When Bank Balance Sheets Are Ugly, Yours Doesn't Have to Be

Only a year ago, in October 2007, the stock market hit an all-time high. Since then, the financial picture has changed drastically.

Hundred-year-old investment banks have disappeared. Trillions of dollars of wealth has evaporated. Residential real estate values have dropped by more than one-third in some places as foreclosures have skyrocketed. Some of those who had counted on a lifetime of savings to provide an extra measure of comfort and security in retirement are rethinking their plans.

The costs of food and fuel have risen sharply. Consumer confidence is down, and it would take about 11 months to sell out the housing inventory that is on the market.

I have been inundated with questions from readers wondering where it's safe to put their cash, whether they should wait to buy a home, and what will happen if the government buys all the bad real estate loans but financial markets don't get better.

It's tough to have confidence in a financial crisis. A home typically represents more than half of a family's net worth. When we're told that its value has evaporated by a third, it's bad enough. But soon, third-quarter financial statements will begin to arrive. When you see the bottom line on your 401(k), you may get nervous all over again.

While it's painful to watch the federal government fumble the ball, it's worse to experience a broken market first-hand, either by not being able to borrow what you need to expand your business or by calculating your new net worth and realizing that early retirement won't be quite as early as you hoped.

What can you do to shore up your confidence while strengthening your personal balance sheet?

· Assess your cash flow. How much is coming in? How much is going out? If you're spending more than you earn, you need to reprioritize some expenses or find a way to bring in extra income.

· Pull a copy of your credit history from AnnualCreditReport.com. In a world that revolves around credit, you have to make sure yours is as good as it can get. Check the report for errors, and then dispute them. Keep in mind that some of your past mistakes may still show up. The key is to make sure those black marks are reported correctly. If you failed to pay a debt but then made good, your report should indicate that the debt was paid in full.

· Keep your debt as low as possible. Pay all your bills on time, and in full, and strive to pay down your credit cards as quickly a possible. Usually, you want to pay off the card with the highest interest rate first, followed by other, lower-interest debts. Aim to have a balance of less than 25 percent of your maximum available credit limit.

· Make sure you have an emergency reserve. Some families don't have any cash on hand but rely on a home-equity line of credit if times get tough. The problem is that some lenders are cutting back or closing credit lines. Try to have three to six months' worth of cash in a savings account you can get to easily. With recent financial news, some people may decide to keep cash on hand (the proverbial "under a mattress") rather than in a bank. However, because most savings and checking accounts at banks and savings and loans are insured for $250,000 for now, you should keep the money in an institution rather than risk losing it at home.

· Put off any unnecessary big purchases. You may have been planning to buy a new car or flat-screen television before the end of the year. If you can make do for another six months, you might be better off. With lousy holiday sales expected, the after-New Year sales should be good next year. If you have to buy now, you may find great deals on cars and some other large purchases. But make sure you understand where your finances will stand once you buy.