Reflecting back over the last twenty-four months, it's been quite a roller-coaster ride. It turns out the global economic system was in a severe crisis, possibly the worst since the Great Depression. Family, friends and neighbors have lost jobs and many of those still working are anxious about future employment and expect pay cuts.
You may feel poorer now than you did in October 2007 when the stock market was at it's peak. Although stocks have partially recovered from the lows of March 2009, many investors aren't confident about the near term. They question their commitment to equities and feel uneasy as the stock market fluctuates dramatically. Residential and commercial real estate have seen better days adding to this crisis in confidence. Local, State and Federal governments are struggling with deficits and seem unable to quickly fix problems (not that they can or should). The tone of political discourse is frustrating everyone.
In many ways, it feels like we've been experiencing a bad dream when feelings of anxiety, lack of control and fear are intense right before we wake-up. Like a bad dream, so much of what has happened is beyond our control. Unlike bad dreams, the effects of this economic crisis are real and have significantly changed the lives of many.
The truth is economic downturns happen. The Great Recession that started in the Fall of 2007 has been worse than most, but the economy and the stock market are cyclical and we should expect ups and downs. We can only hope that future booms and busts are less violent, but there aren't any guarantees.
It's important to look back over the last few years and consider what lessons we've learned. For many of us, these are lessons that we should relearn. Below are 8 important lessons:
- You need a game plan.
A realistic plan for the future will help you stay focused on your goals. With the help of your professional advisor, clarify and then prioritize your goals. Unfortunately, emotions, impulses and hunches wreak havoc on your plans. Review your plan at least annually to determine your progress and to see if you need to make any adjustments.
- Focus on what you can control.
In order to successfully meet your goals (your game plan), focus on the two things you control: spending and saving. You may have some influence over aspects of your financial life, but so much is determined by factors beyond our control like inflation, employment, health, mortality and investment returns. You may influence the timing of certain life events (like retirement) but even then, you may not have a choice. As your plan is reviewed annually, make the necessary adjustments to your spending and saving goals in order to stay on target.
- Low or no debt gives you financial freedom when you need it.
When times are good, when assets are increasing in value, borrowing money can work very well, especially when interest rates are low. But when assets are going down in value, debt becomes a significant burden, making it difficult if not impossible to meet your financial goals. Being debt-free gives you that much more flexibility and makes it easier for you to weather difficult financial periods. While it may not be possible for everyone, consider having no debt when you retire.
- Access to cash (having enough liquidity) matters.
Different assets in your investment portfolio should have different attributes and work at different speeds. Having adequate cash to fund your immediate needs is a tremendous relief, especially when it might be costly to liquidate other assets (like stocks or real estate) in a down-market. Plan for emergencies and other known expenses with six to twenty-four months of cash in money market funds, CD's or other low-risk and liquid investments. Don't be disappointed that you aren't earning any income on your cash-like assets. It's primary attribute should be safety of principal. Your stocks and bonds should be working harder, generating larger long-term returns, but without the safety of cash.
- Managing risk (avoiding large losses) is more important than generating big returns.
Everyone wants great returns with low-risk investments. Unfortunately, it's impossible to consistently have both. Focus on your time horizon and the average rate of return you need to achieve your financial goals. Understand the down-side risk of your preferred portfolio. When would you start to feel uncomfortable if your portfolio dropped in value? How much of a loss could you experience before you would have to change your objectives? If your portfolio suffered a significant loss, how long might it take to recover from these losses? Don't underestimate how detrimental significant losses can be, especially if you are relying on your portfolio income to pay current living expenses.
- Don't give in to your emotions of greed and fear. Don't try to time the market.
Buy low, sell high. It seems so simple, but it's just not possible to consistently and accurately predict the future. Sometimes stock and bond markets seem rational, but more often than not they just walk to the beat of a different drummer. It's impossible to get it right all of the time. And remember, past performance is not a good predictor of future performance.
Most investors fail when they try to time the market. As an example, while stocks dropped significantly in 2008, many investors liquidated their equity mutual funds. In other words, many investors sold stocks when they were low. In 2009, the proceeds from these liquidations went to money market funds and bond funds. While investors were fleeing to the safety of cash and bonds, the stock market rose precipitously. Bad timing.
- During retirement, have guaranteed sources of income you can't outlive.
Many of us have done a good job accumulating assets for retirement. But there comes a time when these assets will need to produce income. Because of increasing life expectancy, this income might be necessary for 20, 30 or even 40 years. Think of social security, pensions and annuities as lifetime guaranteed sources of income. There is peace of mind knowing that income will continue for your lifetime despite stock and bond market volatility.
- Monitor and Adjust
One of the biggest lessons from the last two years is that we can't predict the future and even the best laid plans get off track. That is why it is so important to be clear about your goals and be flexible in how you reach them. Monitoring your progress regularly and making necessary course corrections will give you the best chance to reach your destination.
While the economy and the stock markets are cyclical, your future doesn't need to be totally reliant on the unpredictable. Take the above lessons to heart and your journey will feel less bumpy as you maneuver through and around the many financial challenges we confront on a daily basis
By Peter A. Raskin