4 Smart Money Moves for a Down Economy

Updated on February 23, 2009.

Every day, a shocking new number makes headlines.

The tally for the government rescue plan: $787 billion. The number of job cuts in January: an eye-popping 598,000. And, on Friday, another magic number made headlines: 7200 -- or, more precisely, just below 7200 -- where the Dow Jones Industrial Average found itself dangerously close to a low not seen since 1997. 

For consumers, these numbers should mean one thing: Now's the time to do everything you can to protect your finances. In our first installment, we offer 5 Tips for Navigating Troubled Markets. Here are four additional smart money moves to make now:

The down markets may decimate your retirement savings, but they also provide a rare opportunity: To convert your traditional IRA into a Roth IRA with a reduced tax hit. (For a tutorial on the differences between these two types of IRA accounts, click here.) When you convert a traditional IRA to a Roth, you owe ordinary income tax on every dollar you roll over (unless you’ve made nondeductible contributions to the account).  Fewer dollars in your account spells a smaller tax bill. And if you covert the account only to see your balance dip further, you can always redo the conversion, so you aren’t paying taxes on gains that are now gone.

A big perk of Roth IRAs is that withdrawals taken during retirement are completely tax free. That’s a big gift from the government. Typically, Roth IRAs make the most sense for younger folks since they have a bigger window to benefit from the compounding growth and they’re likely to be in the same tax bracket or higher during retirement. But given the budget deficit and the idea that it will result in higher taxes across the board, the Roth could benefit most people regardless of age.

The one catch with a Roth conversion is that your adjusted gross income must be $100,000 or less. Given the number of layoffs and eliminated bonuses this year, some folks who’ve previously been ineligible may qualify this year. If you're still making more than that amount, the $100,000 limit will be eliminated starting in 2010.

For more on Roth conversions, click here. And for answers to common questions on Roth IRAs, click here.

"Watch every dime coming into your house, because tomorrow it could be a nickel," warns Catherine Williams, vice president of financial literacy for Money Management International, which oversees nonprofit credit counseling agencies. There's no better way to do this than to stick to a budget.

The basic premise of a budget is, of course, simple: Make sure expenses don't exceed income. (Click here for a few easy budget cuts.)  But you also need to find a way to squeeze out some savings, says Donald Ray Haas, a certified financial planner and president of Haas Financial Services in Birmingham, Mich. "Until you accept that, you're in trouble."

If today’s stock market has you spooked, you can get a nearly unbeatable return by focusing on paying off debts instead.

One of the best ways to go about eliminating debt is to attack high-interest-rate credit cards with a vengeance by seeking out the cheapest rates you can find, says Scott Bilker, founder of DebtSmart.com. Look to credit unions, which tend to offer more favorable rates than big-name banks. Or call your card issuer and tell them you've received better rate offers. Lenders would rather lose a little money by lowering your rate than have you move your entire balance and future business to another company.

Mortgages
In this market, prepaying your mortgage may not be a bad idea. Generally speaking, mortgage debt is cheap debt – especially after you factor in the tax break. But prepaying can still give you an after-tax return that’s a lot better than what most folks have earned in the stock market this year.

Think of it this way: By adding an extra $50 per month on a $200,000, 30-year fixed-rate loan financed at 6%, you could whack nearly $28,300 in interest payments from the mortgage. How much of a return is that? For someone in the 28% federal tax bracket, prepaying a mortgage with a 6% interest rate provides a 4.4% after-tax rate of return. (The rate is lower than the mortgage rate because of the tax break on the mortgage interest.) If you think you could invest that same money in the market and earn more than 4.4% after taxes, then you're probably better off investing.

These days, having a low credit score is a surefire way to get rejected for a major loan or mortgage. Even if you gain approval, you'll still end up paying through the nose in interest.

According to Fair Isaac Corporation, which calculates the credit score used most by lenders, an individual whose score is between 760 and 850 (FICO scores range from 300 to 850) can land a 30-year mortgage with a fixed rate of 4.6%, while someone with a score between 620 and 639 will receive a 6.2% rate. Below 620, many lenders won't even make an offer, says Gerri Detweiler, credit advisor for Credit.com.

How to boost your score? A chunk of your credit score is based on having a low “credit utilization rate,” which basically means don’t have maxed out cards. Ideally, consumers shouldn’t use more than 10% of a credit card's available credit line, says fee-only certified financial planner Sheryl Garrett. (Just be careful: Credit card issuers are closing many cardholders accounts these days. If it happens to you, it could send your credit utilization rate soaring. Read our story to find out how.) 

Late payments will also crush your score. If you’ve missed a payment or two call up your lender and ask (beg) that the late payments be removed from your record. The lender is under no obligation to work with you, but, hey, it doesn’t hurt to ask.

Additional reporting by Stephanie AuWerter.