Consumers have plenty to worry about during a challenging economy, and making a wrong move in personal finances could make a bad situation worse. Obtaining cash through credit cards, retirement plans and home equity could end up being a costly quick fix. And complacency over personal investments and looming college costs could lead to missed opportunities for keeping hard-earned dollars.
Here's how to avoid some common pitfalls during an economic downturn.
What to do: credit card spending
1. Living la vida Visa
One of the most common responses to a financial crisis, such as a job loss, is to continue spending with credit cards, says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling.
"We're great spenders but lousy savers," Cunningham says. "We're a hopeful lot of people. We keep thinking that our ship is going to come in."
But the reality is that it typically takes a job seeker one month to replace $10,000 of lost income, she says. So a prospective employee should expect it will take five months to replace a $50,000-a-year job.
Rather than continue a lifestyle financed by credit cards -- and compounding debt in the process -- consumers should "circle the wagons" by figuring out where they spend their money, Cunningham says.
Just as calorie-counters keep a log of every meal and snack, consumers should keep a meticulous watch on incidental purchases like meals in restaurants, nights out at the movies, and, of course, gourmet cups of coffee. Think of it as an expense report to yourself.
"Nobody likes to do it, but you can do anything for 30 days," she says. "Tracking your spending is one of the most basic elements of financial stability."
Once consumers have a handle on spending, do they have go cold turkey on all of the good life's trappings? Not necessarily.
Cunningham suggests that cutting back on some expenses is better than cutting them out.
Comb through cable bills, cell phone plans, and other services for lower-cost alternatives. Folks who haven't watched HBO since the finale of "The Sopranos" or never started a conversation with a text message may rein a few bucks per month by dumping these options.
What to do: credit card spending
- Stop using credit cards.
- Track monthly spending.
- Cut down, but don't cut out, on lifestyle spending.
2. Invading your nest egg
Economic downturns have a way of drying up consumers' liquidity. Meanwhile, creditors only get thirstier. But as tapped-out consumers have fewer options to get cash, they may be tempted to withdraw from an IRA or borrow from a 401(k) plan. Taking cash out of a traditional IRA can lead to a double-whammy of a 10-percent penalty and taxes of at least 25 percent if the individual is younger than 59½, says Ira Marks, a Certified Financial Planner based in Lawrenceville, N.J.
For example, a couple with a combined yearly income of $100,000 who withdrew $25,000 would pay a $2,500 penalty, plus a tax of $6,250 for a total of $8,750, Marks says. State taxes would also be added.
Taxes and penalties would be more for a couple who earns more money. A couple who makes $200,000 annually would pay $10,833 for the same $25,000 withdrawal, Marks says.
There are exceptions, such as if the withdrawal is made to pay for medical expenses, he adds.
Another caveat to note: If the money is replaced within 60 days, there will be no taxes or penalties -- good to know if you need a quick infusion of cash for a college tuition payment before a commission check comes in, for example.