With 2020 in the rearview mirror, and the end of the
pandemic (fingers crossed) in sight, there’s a lot of economic damage to be
assessed. But there are also a lot of personal-finance lessons we can
learn—lessons that will put us in good stead, whatever the economic future
holds.
Lessons about the importance of emergency funds and having
different income streams. Lessons about how this time really isn’t different
(no matter how much it feels different). Lessons about how personal finance is
truly personal. And much more.
These are some of the lessons we heard about when we asked
financial advisers and others to reflect on the past year. It was a year, no
doubt, that many people would prefer to forget. But before we try to wipe those
memories clean, here are some of the things that investors, savers and spenders
would do well to remember.
Emergencies do happen
One clear lesson from the past tumultuous year is that more
Americans should work to build an emergency fund of at least one month of
spending. An accessible emergency fund (kept in an easy-to-access form like a
savings or checking account) can help alleviate the need for drastic cuts in
spending when facing temporary shocks to your income.
While an emergency fund cannot make up for losing your job
and facing long-term unemployment, it can help to reduce the impact of
shorter-term economic disruptions. For instance, last year many households had
members who were furloughed for several weeks while governments had mandated
closures of their employers.
In addition, those facing longer-term unemployment often had
to wait weeks for benefit checks to start to flow in. In such cases, having
several weeks or more of accessible savings can reduce the need to undertake
painful spending cuts or borrow at high interest rates to make required
payments.
We can be financially disciplined
The pandemic has taught us that financial discipline is
possible. The restrictions on life’s pleasures, like travel and eating out,
caused all of us to rethink how much we spend on these activities. We reflected
on our excess indulges and realized the value of spending moderately and saving
intentionally.
Building cash reserves from unspent money on niceties
sparked greater confidence in handling life’s shocks. Many of us appreciated
the extra money to weather job loss, reduced income due to cutbacks or
caregiving responsibilities, and mounting medical bills.
We also start thinking more about how we should spend our
money, whether it was because of sheer boredom or a greater appreciation of life
in the midst of constant Covid-related casualties. Life’s experiences often
serve as the catalyst for changing financial habits and mind-sets.
Buy when others are scared
The best time to invest is when others are fearful. In 2020,
we faced risks unlike any we’ve dealt with in our lifetimes. Being told you’re
in danger triggers all your evolutionary defense mechanisms intended to keep
you safe. Unfortunately, none of these instinctive reactions are useful in the
arena of long-term investing. In March, investors’ fears extended well beyond
their portfolios and into their personal well-being.
It’s common to hear “this time is different,” but there are
two things that tend to remain true of all bear markets. First, buying when the
market is down at least 30% has historically been an excellent entry point for
stocks. Buying stocks in March required you to embrace fear and uncertainty in
exchange for the higher expected returns.
Second, while all bear markets are inherently different, the
common thread is that they always end. Investors must be willing to lose money
on occasion—sometimes a lot of money—to earn the average long-term return that
attracts most people to stocks in the first place. And if you can be a buyer in
times of fear, your chances of earning above-average returns improve.
Manage your risks
The biggest personal-finance lesson from 2020 is the
importance of comprehending and managing risk. Unfortunately, this is one of
the concepts of personal finance where knowledge is lowest, according to the TIAA
Institute-GFLEC Personal Finance Index. While risk is a constant in our life,
we often do not insure enough against the risks we face.
We should ask ourselves: Does my family have the proper
coverage in case of health problems, including the ones created by the virus?
And in case we have a high-deductible health plan, do we have enough to cover
the deductible? And are we covered in case someone becomes disabled? Should we
change or increase our long-term disability insurance? And importantly, do we
have life insurance to protect our family in case of the death of the income
earner(s)?
These are difficult questions to confront and ask, but the
pandemic is a good reminder that it is better to be safe than sorry.
You need a will
There has never been a better time to put front and center
the need for every adult to have a will. No one expected the level of tragedy
that occurred world-wide last year. And people don’t want to think about the
idea of dying one day—a reason why they often kick this can down the road. But
a big lesson of 2020 is that you should be prepared for the worst.
Whether you’ve built a net worth like Tony Hsieh, former CEO
of Zappos (who had no will) or you are worth $10,000, it’s important for the
family you leave behind to understand the wishes you have for your assets and
belongings. It’s also important to check your beneficiary designations. If you
have life insurance, a 401(k) or an IRA, they are a contract of law and will go
to that named beneficiary, whether or not you have a will. People often forget
to update or change those beneficiaries.
Your personal finances reflect your values
The events of 2020 reminded people of the foundational
reasons behind their financial life—their “why.” Many people have reconnected
personal finances with the things most important to them: how they use their
time, how their money fuels their family and home life, what their investments
support and fund, and how their careers enrich their lives. Personal finance
does not exist in a vacuum; it exists in light of what we value most.
Last year has reminded people of what they value and has
also helped identify what is not important. For many people, it’s that all the
details around finance and money should come back to a core
purpose—facilitating the lives that we all want to live. That has real-world
impact on the decisions we make about how we derive income, how we spend our
resources and how we invest.
Retirement plans need flexibility
The Covid-19 pandemic has left more Americans feeling the
need to delay their retirement as both a short-term and long-term financial
fix. And that is a wake-up call for many would-be retirees about the importance
of not having retirement plans and expectations set in stone.
A whopping 81 million Americans reported that their retirement
timing has been impacted by the pandemic, with most believing that they will
need to work longer than they had previously planned, according to a survey on
work and retirement attitudes and expectations that my firm, Age Wave, has just
conducted in partnership with Edward Jones. Most are putting off retirement for
an average of about three years, according to the survey.
For many Americans, a few extra years of work can offer a
financial buffer. It also can provide continuing social connections, mental
stimulation and contribute to a sense of purpose—which, for many people, can be
a silver lining after this difficult year.
Things won’t stay bad—or good—forever
Extrapolating the recent past too far into the future is a
big mistake. This is known as recency bias, and it is one of our biggest
downfalls as humans. Last year taught us a powerful lesson, in both directions.
Optimism was the order of the day early in 2020 with the
market making all-time highs. Compare that with March, when things looked like
they would never recover. In both cases, investors would have been well-served
not to assume the recent past was going to continue forever. Many investors we
spoke with in March wanted to make dramatic changes to their investments
because they were assuming things would continue to get worse.
This is why a diversified portfolio that you can stick with
regardless of the market environment should be the cornerstone of almost
everyone’s investment strategy.
This time is different. Not.
It is always nerve-racking to watch the market go through a
sizable correction as investors find it increasingly hard to differentiate the
economic ramifications versus the results created by the media. When the
downturn is caused by a pandemic, it adds another layer of complexity to the
confusion. The brain says, “This time is different.”
The truth is that each recession is different, but the
discipline which investors adopt to manage their portfolios should remain
intact. Investors with proper asset-allocation discipline that incorporates
liquidity strategy should refrain from giving orders to their advisers when the
noise grows to become overwhelming. Selling orders out of despair led to
liquidating at the bottom in March and missing the unpredictable quick rebound
in April and beyond. The unprecedented global pandemic sweep was met with the
unprecedented speed of monetary and fiscal policy adjustments and the fastest
vaccine development witnessed. It was evident that the market worked itself
out.
This time is no different from any other time. It’s time in
the market rather than timing the market that matters in the long run.
Markets always fool us
It was the year of Covid-19, skyrocketing unemployment, a
shrinking economy, a $3.3 trillion ballooning of the U.S. budget deficit,
racial riots, heated political discourse. Yet, rather than plunging, the U.S.
stock market responded by surging about 20%, as measured by the total return of
the Wilshire 5000 Total Market Index. What gives?
In the 33 days between Feb. 19 and March 23, when the
pandemic gained its foothold in the U.S., domestic stocks plunged nearly 35%.
Many people told me stocks would not recover until we had a vaccine. Even some
people who realized the phrase “this time is different” was the costliest
phrase in investing told me, “This time really is different.” (Admittedly, if
going into the year I had known what was going to hit us, I’d have bailed on
stocks.)
Why did stocks recover and soar in the wake of such horrible
economic news? The weaker explanation is that the decline in future corporate
cash flows was less than the reduction in the discount rate used to value those
stocks. This was caused by plunging and now near-zero interest rates. The much
stronger explanation is simply that the stock market continues to fool us.
Lesson learned: If we can’t even explain the past, just
think how futile it is to try to predict the market’s future.
You should have a three-bucket strategy
The Covid-19 recession has proved once again that every
investor should always have an investment plan and strategy that can weather
events such as what we have experienced.
A three-bucket strategy is a wise approach as investors
rethink how they should invest their money. A short-term bucket should have one
to two years of expenses in short-term instruments such as cash or short
duration bonds. An intermediate-term bucket should be for monies not needed for
two to five years, such as core bond funds. A long-term bucket should consist
of money not needed for at least five years and can be invested in equities.
This approach will prepare investors for any short-term risks that arise, such
as coronavirus-related recessions, without sacrificing the integrity of their
portfolio.
Rebalancing pays off
Rebalance your portfolio when market movements cause your
equity mix to stray from your target percentage. Doing this—buying more
equities when under target or selling when they are above—is a good way to buy
low or sell high.
In most years, rebalancing helps your portfolio’s return by
a percentage point or two. Once in a while, it can double or triple this when
equity markets decline steeply and recover, like during the 2007-09 recession.
There hasn’t been such an outsize rebalancing opportunity until last winter
when the pandemic hit.
However, you won’t realize these benefits unless you
actually do the rebalancing. Otherwise, all you will realize is your fear of
missing out when markets do eventually turn.
Stay invested
Last year’s tumultuous market reinforced the importance of
staying invested. It looked like financial markets were doomed near the end of
the first quarter. We saw days where markets went down over 10%. Many investors
panicked and went cash fearing the worst. Since then, the markets have rallied
and anyone who tried to time the market and go more conservative is probably
feeling a bit of regret.
Have a side gig
Just as investment advisers recommend having a mix of
investments in your 401(k) to minimize stock-market risk, it’s critical to have
a mix of income sources. Many global citizens took the pandemic as a call to
action and used technology to create new income streams through blogging,
selling courses, writing e-books, posting video content, coaching or
consulting, setting up an online shop, investing and so much more. In the 21st
century when the majority of transactions occur digitally via the web,
technological literacy is as critical as financial literacy.
Yes, bonds are still important
Many investors are quick to dismiss bonds given their
historically low yields. However, the events of the past year have reinforced
the importance of including fixed income within one’s portfolio.
When Covid-19 first hit, from mid-February to the end of
March, the S&P 500 plummeted 34%. A diversified portfolio of equities and
fixed income outperformed the broad stock market during the scariest times of
the year. The stabilizing bond exposure helped many investors stay the course
and minimize emotional selling during this time.
Having bond exposure in early March also provided investors
with a wonderful rebalancing opportunity. As investment-grade bonds
significantly outperformed the market, investors could use proceeds from
selling bonds that stayed flat or appreciated in value to buy stocks that were
trading at a discount from just a few weeks earlier.
Additionally, bond exposure helped the many Americans who
had to liquidate investment assets to meet their cash-flow needs as employees
were laid off or furloughed from their jobs during the year’s quarantine.
Selling their bonds provided a more stable cushion for many investors. Being
forced to sell stocks at rock-bottom prices instead could have had a
devastating impact on their finances.
Click here for the
original article.