To update Thomas Paine’s famous quotation, these truly are the times that try investors’ souls. The S&P 500 is down over 20% this year, while the tech-heavy NASDAQ has fallen over 33%. Rising interest rates have pushed down US aggregate bond funds returns this year by over 16%. And, of course, inflation has increased to an annualized rate of 8.2%, bringing new uncertainty to a generation of investors accustomed to seeing little to no inflation. Apocalyptic daily headlines greet readers of financial news, pointing to more potential market losses, layoffs, and recessions. Is there hope for our finances? What can we do in the face of persistent bad news? While there are many areas in which we are powerless to act, there are things we can do during the turmoil, including steps to set ourselves up for a more profitable future in the eventual recovery.
Here are some things you can focus on to build a better financial tomorrow, even during these times of turmoil:
First, don’t panic.
Fear almost always leads to short-sighted decisions with long-lasting negative consequences, especially when it comes to our finances. It’s painful to see the drop in your 401k or IRA balance, but a market upswing can happen quickly. Keep in mind that 2020’s COVID-related 34% stock market drop was completely reversed in only 33 days. Who knows how long it will take for the market to reach new highs from the current bear market, but panic selling now will prevent you from taking advantage of the recovery.
Build your emergency fund.
Whether you are working or retired, having an emergency fund is an essential element of any financial plan. The typical size recommendation for an emergency fund is three to six months of your income, which is a reasonable estimate. Some may need a larger reserve, such as those households with only one income or if your job isn’t stable. This is particularly important in times of widespread layoffs like we are currently experiencing.
Get higher returns on your cash holdings.
One positive impact of the increasing interest rates is that savers can earn more on their balances. If you’re holding your cash and emergency funds in a local brick-and-mortar bank, you can most likely do better elsewhere. Many online banks (with FDIC insurance) are paying much higher rates. With increased inflation, I-bonds are also a great option to consider. Short-term CD’s and Treasuries also pay much more than in the recent past. For example, three-month Treasuries, fully guaranteed by the US Government, have a rate of return of over 4%.
Pay off debt.
With raising interest rates, eliminating debt is even more important. Many types of debt are variable rates, such as credit cards, which now carry an average interest rate of nearly 19%. It’s difficult to make progress in your debt reduction when rates are so high, especially if you’re making the minimum payment. Even zero percent debt is a drain on your monthly cash flow, so working toward debt elimination is always a good idea.
Continue your investments in the stock and bond markets, and rebalance periodically.
Times like these lead many investors to sit on the sidelines. I understand the emotion behind it, but it’s the exact opposite of what you should be doing. Continue to invest in the market, whether through your workplace 401k or personal IRAs. With stock prices currently down, monthly contributions to your accounts will buy more shares than they did a year ago. This principle, called dollar cost averaging, not only builds great investing habits, but also allows you to take some of the emotion out of the process. You don’t have to worry about whether it’s a good time to invest! Simply make your contribution each pay period (or month for IRA contributions). If prices are still down, you’re buying the shares on sale. If they are up, you’ve made money on your prior investments. You win either way.
Be sure to also rebalance your holdings periodically. Suppose your investment plan is to hold 60% in equities and 40% in bonds. While both are down this year, stocks are down more than bonds. Today, your allocation may have moved closer to 50%-50%. Rebalancing back to 60%-40% would require selling the relatively better-performing sector (bonds) and buying the poorer performer (stocks). Again, this process ensures you are taking advantage of market drops and setting yourself up for larger gains when the market eventually recovers.
Focusing on the things you can control may provide some comfort to you today, as well as set yourself up for a better financial tomorrow. Many investors, including myself, can trace long-term investing success to how we handled the down markets. Steadfastly refusing to sell due to fear, and instead increasing equity holdings at depressed prices, is the formula for long-term wealth building.
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