This Time it's Different (but stick to your plan!)
2020 has definitely been a different year for all of us. As I have had conversations with many of you this year, I have learned so much about the way that we adapt and the things that are really important to us. I have heard about struggle and loss and I have also heard about great success and joy. In the world of finance, this year was different as well. The word, “unprecedented” has been thrown around a lot. The stock market touched down 32% in March only to finish the year near record highs. Recession, stimulus payments, loan deferrals, and low interest rates have all been part of our calculations this year. It is very simple to be left wondering how to proceed. Do changes need to be made? Will this time be different? While it is important to adapt and adjust, when it comes to finances there are some important fundamentals that you should stick to.
Interest rates are at extreme lows. This time might be different. The government is going to accommodate growth and recovery for as long as it takes, and some have guessed that we will even see negative rates from the Fed at some point. While low rates are great for taking loans, they are frustrating for savers because we can’t earn any interest on our safe money.
However, it is important to keep some of your money in cash. Any cash left too long in a low interest account will lose money to inflation and taxes. However, if you need money for an expense that is going to happen in the next 12-18 months, leave the money in a cash instrument (savings account, CD, money market, high-yield savings, etc.). The fundamentals say to not take the risk of losing principal if you are going to need the money soon.
This definitely seems different. Right now, mortgage rates are at lows that I haven’t seen in my career. As I mentioned above, low interest rates are fantastic for taking a loan. The power of low rates makes big purchases more possible. If you have ever thought about home ownership or upgrading your home, now seems to be the time.
However, it is important to remember some fundamentals when it comes to debt. Don’t overextend yourself. Your total housing cost typically shouldn’t be more than 35% of your net income. Even though loans are more affordable, there is a lack of inventory and costs of homes have been driven up quite a bit. Make sure to do your research and get professional help to guide your decisions.
Also, if possible, try to eliminate any consumer debt like credit cards and personal loans and pay off the balances each month. If you have the opportunity to lock in a fixed low rate vs. a variable rate, go for it. This is typically going to help you reduce the cost of the loan over time.
Remember that I said any money left in cash too long will start losing money to inflation. This means that if you have too much money in cash or you don’t plan on using the money within the next 18 months, you should invest it for a higher return. Any investment that is not a cash instrument will involve taking some risk, however if time is on your side you should be earning a higher average return than money in a savings account.
This year was different in the stock and bond markets. The markets moved much quicker than we had ever seen before. However, the fundamentals still apply. Bonds provided some stability when compared to stocks as their value didn’t fluctuate as much. Stocks were volatile but provided us with the highest returns so far.
For your financial goals it is important to consider your risk. It is really exciting to see the stock market rally. Especially in times like this, there are great investment opportunities. It is also tempting to be overallocated to investments that are more risky than you are used to. Keep your goals in mind and avoid speculating with money that is important for your goals. Allocate any money that needs to provide income in the next 2-4 years to bonds. Money that will stay invested for 5 years or more should be invested in stocks.
Think about these fundamentals:
Money that you need access to in the next 12-18 months: Cash savings
Money that needs to earn interest and stay safe: Bonds/Bond funds
Money that needs to grow steadily: High quality, dividend-paying stocks/stock funds
Money that needs high long term growth: Broadly-diversified stocks/stock funds
Make sure to talk to us about your allocation and what makes the most sense for your personal needs and ability to take risk.
Think long term
Changes to the laws this year made it easier to take early withdrawals from retirement accounts. The laws also allowed us to defer payments on debt like student loans. For those in emergency needs, these laws were a lifeline. However, for those who are on track financially it is important to consider the effects short term decisions will have on your future. If possible, you shouldn’t rob your retirement accounts for current needs. If you did need to take money from retirement this year, it is important to start planning how to pay that money back. Also, if you have been in loan forbearance, you need to prepare to begin making loan payments again.
Automated retirement savings are the key to staying on track and it is important to review your retirement savings each year around this time to make any adjustments and increase your savings as much as possible for the new year.
Paying off your loans involves reviewing your budget. Now is also a great time to review your expenses for the last year and make a plan to get ahead in the next year.
Cheers to the year ahead!
Financial success is more about the journey than any destination. We will always have setbacks. Each time will seem different.
A good financial plan is really about feeling educated to make some consistent good decisions. When life happens and the circumstances change, we can adjust. We can be ready for the big opportunities and the periodic downturns. All along the way we can make small consistent smart choices with our money. These little consistent wins add up over time and help us feel peace of mind when we need it the most.