Year-end Planning: 20 Things You Can Do to Organize Your Finances
It's November and there’s not better time than the present to get your financial house in order. Indeed, we're in that sweet spot before things begin to wind and just ahead of a busy holiday season.
While preparing a comprehensive financial plan is essential to financial independence mastery, today we're talking about doing the simple stuff: reviewing and making last-minute retirement savings contributions, fine-tuning your investment portfolio, reviewing your spending plan, and some general housekeeping regarding your equity compensation.
Taking a few minutes to check these items could put you on track to starting 2023 on the right track.
Here are 20 things you can do to organize your finances before the end of the year:
- Rebalance Your Investment Portfolio
- Top Off Your Child's 529 Account
- Maximize Your IRA Contributions
- Consider a Backdoor Roth Conversion
- Rollover Your Old 401k/403b
- Tax Loss Harvesting
- Review Your Restricted Stock Concentration
- Review Equity Compensation Tax Withholding
- Review Expiration Dates for ISOs
- Sell ISOs that are Down in Value
- Evaluate Your Expenses and Create a Spending Plan
- Review Your Fixed Income Needs
- Look Over Your Credit Report
- Set a Budget for Holiday Spending
- Review your Employer Benefits Statement
- Spend Down Your Flexible Spending Account
- Review Your Estate Plan
- Update Your Designated Beneficiaries
- Review your Insurance Policies
- Review Your Emergency Savings Need
1. Rebalance Your Investment Portfolio
If you still need to do so, now may be a good time to rebalance your investment portfolio. To start, ensure that you've appropriately evaluated your risk tolerance and identified a suitable diversified asset allocation strategy that suits your goals, needs, and objectives.
With your long-term strategy in mind, sell investment holdings above your target allocation, and use the proceeds to add to positions where your holdings are underweight.
Doing so may ensure that you're not taking more investment risk than you're already comfortable with while ensuring that your overall portfolio is aligned with your long-term investment goals.
2. Top Off Your Child's 529 Account
Depending on your circumstances, a 529 account may be an excellent way to save for a child's college education expenses. If extra cash is available, try topping off your child's 529 if you still need to maximize contributions for the year.
While there is no limit for annual contributions, the gift tax exclusion for the year is $16,000 per child ($32,000 for couples).
3. Maximize Your IRA Contributions
If you've maxed out your 401k/403b and still have some cash in savings, consider contributing money to your IRA. Putting money in an IRA allows your money to grow tax-advantaged, potentially boosting the overall value of your account compared to a taxable brokerage account.
In 2022, your total contribution limit to traditional and Roth IRAs can be at most $6,000 ($7,000 if you're age 50 or older). And be mindful of income limits before making contributions.
4. Consider a Backdoor Roth Conversion
If you've maxed out your 401k/403b and are otherwise not eligible to contribute to a Roth IRA this year, consider a Backdoor Roth Conversion.
As you'll recall, the way a Roth conversion works is that the government gets its share of your money now (compared to being taxed when funds are withdrawn years later), allowing investments in a Roth to grow tax-free. When it's time to take the funds out of the account, the money comes out tax-free.
What's more, a Roth account is not subject to required minimum distributions (RMDs), reducing unnecessary cash distributions in retirement.
5. Rollover Your Old 401k/403b
If you've left a job this year, go back and ensure you have a plan for that old 401k or 403b. Generally, you have two options for your money with an old employer retirement savings plan.
First, if your new employer's plan allows it, you can move the funds from your old retirement plan into your new plan.
Your second option is to open an IRA with a trusted advisor and transfer the funds over to your individual account. As long as the transfers are custodian-to-custodian, and you avoid holding back funds from the withdrawals, the transfer likely will be treated as a non-taxable event.
6. Tax Loss Harvesting
We've experienced arguably one of the most volatile financial markets since the Global Financial Crisis in 2008. As a result, you're likely holding onto losses in your investment portfolio that could provide you with a tax benefit this year. And that's where tax loss harvesting comes in.
Tax loss harvesting is the process of offsetting long-term capital losses against gains. This process applies to taxable investment accounts and involves identifying and selling holdings in a loss position to offset gains in other holdings. Before you implement tax loss harvesting in your portfolio, beware of wash-sale rules that could disqualify you from recognizing the benefit of tax loss harvesting.
7. Review Your Restricted Stock Concentration
Do you have a plan for your restricted stock? It's quite common for restricted stock recipients to simply allow their vested awards to accumulate in their employer plan's brokerage account.
Market volatility this year, particularly in tech-related sectors, is an important reminder of why investment diversification is essential to preserving your wealth for the long term. That's why you'll likely want to take a moment to review your company stock holdings and develop a plan to reduce your risk exposure.
8. Review Expiration Dates for ISOs
If you've recently left a job where you had ISOs, or are approaching your ten-year anniversary with an employer who has offered this benefit to you, now may be the time to evaluate the expiration date for your stock options.
Review expiration dates for outstanding stock options and deadlines for option exercises. If you've left a job in the past year, go back and review your previous benefits and ensure that you're not leaving money on the table.
9. Sell ISOs that are Down in Value
If you have vested ISOs that have fallen in value this year, now may be an excellent time to exercise those options. Remember, if you plan to hold your company stock for the long term, you may be subject to the Alternative Minimum Tax (AMT) when you exercise your options and don't immediately sell your holdings.
One way to lower your AMT due is to exercise your options when your ISOs' fair market value (FMV) declines, narrowing the spread between the FMV and strike price of the option.
10. Equity Compensation Tax Withholding
Review your withholding rate for equity compensation, such as restricted stock or stock options. If your employer has set your flat withholding rate for supplemental income (equity compensation) at the 22% standard rate, you'll likely need to come up with cash to pay taxes due this coming April.
Nevertheless, to avoid underpaying taxes next year, you can change your withholding rate by updating your W-4 form through your employer's HR system.
11. Evaluate Your Expenses and Create a Spending Plan
With the holiday season just around the corner, now may be a good time to review your spending trends to evaluate whether your spending is aligned with your long-term financial planning goals.
More specifically, take a close look at your discretionary spending (outside of insurance, mortgage, utilities, etc) and look for areas where your spending may be inconsistent with your overall plan for the year.
12. Review Your Fixed Income Needs
If you're already Financially Independent and living off of your savings, now may be a good time to review your anticipated spending need for the coming year. This evaluation is crucial given that inflation has run well above its 2% average over the past year.
This means that your living expenses will likely be higher in the coming year, and so you'll want to ensure that your current savings distribution is sufficient to meet your lifestyle needs without derailing your retirement plans.
13. Look Over Your Credit Report
A best practice we recommend around here is reviewing your credit report no fewer than once per year. And there's no better time than year-end to check your credit report. Pulling your credit report will not affect your credit score, and you can typically download a copy of your credit report for free from either of the three major credit reporting services (Equifax, Experian, and Transunion).
You want to look for suspicious activity, like a new account that you may not have opened or balances on cards that may have been dormant. If you find inconsistent activity on one or more of your accounts, call the reporting institution (bank, credit card company) to get more information. If you feel that the activity reported is inaccurate, you can file a dispute with each reporting agency to get your report corrected.
Either way, check your credit report to gain some peace of mind that your financial accounts are secure and in good order.
14. Set a Budget for Holiday Spending
With Christmas and the holidays right around the corner, many individuals may be tempted to put all spending on their credit cards and deal with the balances in the new year. More often than not, however, spending blindly might leave you with debt that you have to deal with all of next year.
That's why it's essential that, before heading into your holiday spending routine, you set limits you're your spending. One way to do so is to list all the people you want to purchase gifts for this year.
Track this list on your phone, in a notepad, or in a spreadsheet. Then, set a budget for each individual. Tally up the total amount you plan to spend this year and ask yourself, "do I feel comfortable spending this much money?" If the answer is no, consider revising your list. Either way, move forward with a spending plan and stick to your budget.
15. Review your Employer Benefits Statement
The end of the year is typically when most employers offer their annual enrollment period. As you head into this time, consider whether you've experienced life changes or anticipate major life changes in the coming year.
Then, take a moment to review your elections and evaluate whether your medical/dental/vision plan, related deductibles, and out-of-pocket expenses are consistent with your current lifestyle.
You'll also likely want to review your group insurance benefits. For example, your employer may offer optional life or disability insurance coverages above and beyond the basic plans you may already be enrolled in.
Many employers offer an opportunity to make last-minute changes in December if you missed your window to change your benefits elections. Either way, review your benefits to understand your coverages for the upcoming year.
16. Spend Down Your Flexible Spending Account
A flexible spending account (FSA) is a limited savings vehicle offered by some employer-sponsored medical plans that allow workers to set aside funds to pay for medical expenses on a pre-tax basis.
While the tax benefits give you more money towards paying for doctor's visits or supplies, the downside is that the account is typically a use-it-or-lose-it situation.
If you have a good chunk of change in your FSA, now may be the time to schedule a visit with a care provider for a check-up, buy a new pair of glasses, or stock up on medical supplies before the money is lost for good.
Here's one list of FSA Eligible Expenses: https://www.wageworks.com/takecare-mynewfsa/healthcare-fsa-carryover-overview/eligible-expenses/
17. Review Your Estate Plan
Estate plans aren't just for the mega-rich. They're relevant to most individuals and, at the basic level, include a Will, Healthcare, and Financial Powers of Attorney.
At this time of the year, you'll want to consider putting together your estate plan. Preparing your estate plan can be as simple as answering:
- where will your assets go should you and your spouse pass unexpectedly and
- who will be responsible for managing your financial affairs when you're unable to do so yourself.
If you already have an estate plan, now is an excellent time to look it over. Ask yourself whether you've experienced any life changes that may warrant an update to your estate plan.
At the same time, review your designated agents (executor, powers of attorney) and determine whether the individuals you've elected to manage your financial affairs are still appropriate, given your current circumstances.
18. Update Your Designated Beneficiaries
You can designate beneficiaries for your various financial accounts outside of an estate plan. Such designations include elections in your employer-sponsored retirement plan (401k/403b), IRA, and life insurance policies.
Additionally, titling your bank account with your spouse or partner can help you shorten the estate planning process and simplify financial choices when needed. Take the time to review the beneficiaries of your various financial accounts and make updates where necessary.
19. Review your Insurance Policies
Got a few extra minutes on hand? If so, now may be the time to evaluate your property and casualty premiums and shop around for some savings.
For example, many firms offer discounts for package policies that include homeowners and auto policies combined at one insurance company. As you shop around, ensure that your coverage limits reflect your assets and lifestyle. While you don't want to be underinsured, you may be paying for coverage already offered by an existing plan, like your employer's group policy.
Also, take the time to evaluate other coverages you may have yet to consider. For instance, if you have children, a term life insurance policy could be beneficial to providing your family extra financial protection and peace of mind. An Umbrella Policy can also help you avoid the financial setbacks related to potential lawsuits if someone were to get injured on your property.
20. Review Your Emergency Savings Need
Do you have money saved for a rainy day? Maybe you do, but do you have enough money saved to cover an unexpected loss of income?
Whether your furnace goes out or if your car is out of warranty and you have an unexpected expense, ensure that your savings are adequate to cover unexpected expenses.
How much should you have saved? The actual amount likely will vary from household to household, but one rule of thumb we use is having enough money saved to cover six months of living expenses.
At the very least, use this time to ensure that you have set aside enough money to cover the unexpected as you look ahead into the new year.
Next Steps
Certainly, there are many things to keep you busy heading into the holiday season. Nevertheless, before things get hectic in the coming weeks, my challenge to you is to identify at least three of the above items to tackle before the holiday hustle distracts you from your financial goals. You can spend as few as 90 minutes over the coming month working through these items. And yet every little step moves you one step closer to mastering your journey to financial independence.
How Much Do You Need to Buy a House?
The answer to this complex question involves not only the initial costs of buying a home, but also your ability to keep up with the long-term financial responsibility of owning it. The process starts with making a list of the features you want in the home. Next, look at the neighborhoods and the surrounding amenities. Then, research the location’s listings and the final selling prices. The information provides a good view of the market’s activity and the cost of the homes in the area.
How Much House Can You Afford?
The typical industry formula is to calculate your potential mortgage against your annual income and current debt. This is called the 28/36 rule, and it determines how much of a mortgage you can qualify for.
The "28" (known as the front-end ratio) means your monthly mortgage payment (including taxes and insurance), shouldn't exceed 28% of your pre-tax income.
The "36" (known as the back-end ratio), means your entire debt load, which includes your mortage as well as car payments, credit cards, student loans, and other monthly debt payments shouldn't exceed 36% of your pre-tax income.
Having a formula is nice, however what you can actually afford to buy will vary depending upon where you are buying (your geographic area), your spending habits, the cost of living in your region, and your overall financial health.
Out of Pocket Costs
Most homebuyers have no idea of the additional costs not covered in the mortgage loan. The out-of-pocket costs include the down payment, home appraisal, cash reserves and a home inspection.
- Down payment percentages range from 3-20% depending on the loan type.
- Appraisals average from $300 to $600. The purpose is to confirm the purchase price does not exceed the market value of the home. The seller may pay this fee. If the home appraisal comes in lower than the purchase price, it may be time to renegotiate.
- Cash reserves in the bank are dependent on the loan conditions. It's a safety net for the bank, preventing early defaults on a new loan.
- Home inspection cost is $200 to $400 and worth the expense before closing, since the seller may be obligated to pay for the repairs.
Total Cash Needed
The numbers may change depending on the lender, your credit and the seller. Let’s say you found a home and made an offer to purchase it for $400,000.
- You’re approved for a 30-year fixed loan with 20% down – no private mortgage insurance (PMI).
- Reserves may include the loan principle and interest, annual real estate taxes, and insurance, along with two months of mortgage payments.
- Total cash to buy this $400,000 home could reach $95,000.
Closing Costs
Rolled into the loan are closing costs at 2-3% of the loan amount. Using the above sample – at 3%, fees could reach $10,000 dollars. You could negotiate with the seller to pay all or a portion of the closing costs.
Conclusion
Before you buy, make sure you run your numbers to make sure you will be 100% comfortable with your new mortgage payment. Also ensure you understand the terms and conditions of your loan, as they could significantly increase your out-of-pocket expenses. In addition, try to avoid closing delays, which could cost you prorated interest.
Are You a Financial Procrastinator? 5 Ways to Overcome it
Procrastination is a real thing that can trickle into other areas of your life. Financial procrastination is one of those areas.
What is Financial Procrastination?
Financial procrastination is when you have financial obligations and moves to make, but you put those decisions aside on a continuous basis. For instance – you know you need to balance your checkbook, but you continue waiting until things are going wrong. Or, you may have student loans and need to apply for a deferment but you let the time lapse and end up in the credit bureau.
Can you overcome it? Yes. Do you have work to do? Again, yes. Here are a few suggestions on how to get past your procrastination:
1. Accept Where You Are
You may feel as if you have to do too many things to get past the point of no return. The key is in accepting where you are, knowing you may never be ready to tackle everything, and start from there. Motivating yourself, even when you don’t want to, allows you to make baby steps toward making things right.
2. Time It
When you decide to take those baby steps, don’t overdo it. Give yourself time to get adjusted to figuring things out. Taking five or 10 minutes to do something simple is the first step in this transformation. Perception is everything. Don’t shy away because you feel as if things are too far gone. Address it one step at a time.
3. Give Everything a Deadline
If you work well under pressure, put your financial tasks on a deadline. With a firm deadline in place, it is easier to look at the task as something that absolutely has to be done, rather that something that can be put off again and again.
4. Set Some Goals
Your baby steps should be tied to your goals. What do you need to do? How can it be accomplished? Even if it’s going to open up that new bank account, you should set a goal and a date by when it should be done. This way, you’ll always hold yourself accountable.
5. Reward Yourself
When you tackle those financial issues, take some time to reward yourself. These rewards can be tied to your short and long-term goals. For instance, if you want to go see a movie, give yourself an hour to get things done before you have to leave. If you haven’t done what you were supposed to do, then no movie. Or, set yourself up for completing a number of financial tasks. For every task you complete, you get to surf the net, or watch something you really wanted to. It’s a different type of motivation, but could work in your favor.
Having someone close to you around to monitor your progress can go a long way. You’ll hold yourself accountable, but someone else will be holding you accountable too. Once you establish these healthy habits when it comes to your finances, the stressfulness of the situation may help prevent your procrastination.
Mid-Year Financial Check-In: Are You On Track To Reach Your Year-End Goals?
The summer season is winding down and fall is fast approaching. And whether you’re excited for the cooler months ahead or still holding on to the last bits of summer, mid-year is officially here. Now is a great time to slow down and take stock of your entire financial picture and how it’s lining up with your year-end goals. Below are a few ways in which you can check-in with your financial health as summer comes to a close.
Check-In #1: Evaluate Current Debt
Holiday retail sales hit a staggering $719 billion last year, meaning our spending won’t be slowing down anytime soon as we head into the holiday season.1 In fact, people expect to spend around $800 on Christmas presents alone - that doesn’t include holiday parties, decorations, travel, etc.2 With your spending likely to increase towards the end of the year, now is a great time to evaluate any current debt you may have accumulated throughout the year.
You may want to write down all debt currently owed including credit cards, student loans, mortgages and car payments. Be sure to also keep track of the minimum payment amounts and due dates. Once you have everything laid out and organized in one place, you can begin focusing on how to minimize or eliminate certain debts. For example, if you’ve been making regular payments to your credit card company, you could try negotiating a lower interest rate or look into transferring the debt to another company. Seeing all your debt in one place may sound stressful, but it’s an important first step in taking control and minimizing what you can.
Check-In #2: Check Your Credit Score
Can you remember the last time you checked your credit score? It’s possible (and likely) that your credit score is really only thought about when it’s time to apply for a new credit card, take out a loan or make any other large purchases. If you haven’t given it a good look in a while, now’s the time. Your credit scores can give you a decent overview of how your financial health is doing. In addition, it can help make you aware of any potential red flags such as missed payments or unauthorized use of your credit cards and identity theft.
Check-In #3: Readjust Your Retirement Fund
If you contribute to an employer-sponsored retirement fund such as a 401(k) or 403(b), take some time to check in with your account. This is especially important if you set automatic deposits a year or two ago and haven’t thought about it since. In fact, it is especially important to revisit your retirement fund in 2019 because the IRS raised the maximum contribution limit from $18,500 to $19,000 a year for those under 50.3 If you’re heading towards retirement and trying to make the most out of your employer-sponsored plan, you now have the opportunity to save even more in your account.
Check-In #4: Refill Your Savings
With family vacations, weekend trips and summer concerts, enjoying the warmer weather can cost quite a bit. The temptation to tap into your savings is strong, and if you did - you’re not alone. But as we gear up for the holidays, now’s the perfect time to work on filling it right back up. And if you set a savings goal for the year, do a quick progress report. Have you nearly reached your goal? Then you may want to challenge yourself to save even more. And if you’re nowhere near it, focus on adjusting your spending habits to better support your savings goal.
Check-In #5: Rethink Your Goals
Think back on everything that’s happened this year. It’s likely some unexpected events occurred, isn’t it? From unfortunate events like divorce, death or property damage to exciting celebrations like proposals or births, moments large and small can have a significant impact on your financial standings and goals. Revisit the goals you made at the beginning of the year and make sure they are still well-aligned with your current standings. If not, take some time to look at your entire financial picture and future needs, and create new goals that better reflect them.
With a bit of time to prepare, you can enter the second half of the year feeling financially confident and on track to meet your goals. As vacations wind down and school starts back up, find some time to yourself to readjust, reevaluate and rethink as needed to stay on track for the rest of the year.
- https://www.statista.com/statistics/243439/holiday-retail-sales-in-the-united-states/
- https://www.statista.com/statistics/246963/christmas-spending-in-the-us-during-november/
- https://www.irs.gov/newsroom/401k-contribution-limit-increases-to-19000-for-2019-ira-limit-increases-to-6000" rel="noopener noreferrer
6 Step Guidebook to Setting Achievable Financial Goals
We won’t sugar coat it — achieving your financial goals isn’t always easy. But if you don’t create a plan based on your goals, you’re only making it harder on yourself. In fact, American’s with a plan in place are more likely to make positive progress towards achieving their financial goals. In a recent survey, 56 percent of people with a plan in place reported making good or excellent progress towards their savings needs, compared to only 24 percent of those who didn’t.1 As you look to find financial well-being, we’re offering six steps you can follow in creating achievable financial goals.
Step 1: Give Your Goals a “Why”
When it comes to numbers, it can be hard to evoke an emotional response. That’s why it’s important to give your goals a “why” when you can. Placing a reason behind the numbers can be a big motivator in achieving your financial goals. Think about the difference between “I want to pay my student loans off faster” and “I want to pay off my student loans faster so my wife and I can buy a house and start our family.” Remembering why you’re passing up on those concert tickets this month can help make your sacrifices a little easier to make.
Step 2: Make Your Goals Measurable
Ambiguity won’t be your friend as you work to set financial goals. Focus on being as specific as possible instead, your goals should have a measurable and definitive finish line. This will help you track your progress and feel a sense of accomplishment once you achieve your goals. For example, if you have a goal to save money for a down payment on a new car, choose a number. While you may not know exactly what car you want or how much it’ll cost yet, put an estimate to your goal. Instead of saying “I want to save some money and buy a new car next year,” try “I will put $250 in a separate savings account for the next 12 months that will be used as a down payment for a new car.” This provides a clear, definitive goal that you can track month after month.
Step 3: Be Reasonable
You can follow every step in this guide, but if your goal simply isn’t reasonable — you likely won’t attain it. As you look to set a goal, you must evaluate your current financial standings in comparison with your desired financial picture. If you’d like to accumulate a certain amount of wealth by the end of your 30’s, you need to figure out how it can be done. If your current saving and spending habits support this goal, then you’re likely on the right track. But if you’re often spending more than you’re saving, then you may need to either adjust your goal or adjust your current spending habits.
Step 4: Set a Budget
While we mentioned it in step three, evaluating your spending habits is a tip worth repeating. If your spending habits don’t support your goals, you’re likely fighting a losing battle. Create a monthly budget that supports your future financial goals and current needs. A popular budget breakdown is 50/30/20:
- 50 percent on needs (groceries, rent/mortgage, utilities)
- 30 percent on wants (shopping, eating out)
- 20 percent on savings and debt repayment
For example, if your income after tax each month is $4,000, you’d spend $2,000 on necessities like your car payment, electric bill and rent or mortgage, $1,200 on date nights, clothes shopping and weekend trips and $800 would go toward your student loans and savings account. While everyone’s financial circumstances and current needs differ, this ratio can be a great place to start as you look to draft a budget.
Step 5: Balance Short-Term Needs and Long-Term Goals
Money is nothing more than a tool. The reason you set financial goals in the first place isn’t to simply accumulate more money, it’s to accomplish something that’s pertinent to you and your happiness. And while your future happiness is important, it’s crucial to strike a balance between your long-term goals and your needs or wants for today. You shouldn’t be passing on all trips, vacations, home renovations, car buys or celebrations now because you’re saving for retirement 30 years down the line. Yes, your retirement savings is important. But you need to remember to enjoy what you have today as well. And, of course, the same goes for the other way around. Spending all your wealth today could leave you in a tough spot later down the line.
Step 6: Higher Income Doesn’t Equal Success
Are you ever surprised when you hear of celebrities declaring bankruptcy or pro-athletes having to sell their house? It makes sense to think that a higher income level means more wealth and financial success. But whether you make $40,000 or $400,000 a year, it often doesn’t matter how much your income is. Your wealth and the success of your financial goals is dependent, rather, on what you do with it instead. If you make $400,000 a year but spend $500,000 on frivolous expenses, you’re not building wealth or finding financial success. But if you’re making $40,000 and putting a sizeable portion away in savings each year, your wealth is building over time. As you look to set financial goals, remember that it’s not always about how much you have, it’s about what you do it with it that determines your success.
If you have a financial milestone you’d like to start preparing for, it’s important to begin with a plan. Evaluate your current needs and spending habits to develop a realistic goal and plan of action based on your unique financial picture.
Three Things You Can Do About Inflation
Inflation is on a lot of people's minds right now.
And for a good reason.
While we tend to hear about inflation in terms of percent changes in government reports, chances are, you've likely experienced its natural effects in everything from higher prices at the grocery store, gas pump, restaurants, and utility bills.
Prices change constantly, so why should you care about inflation now?
Well, other than the fact that inflation is at a 40-year high, it's crucial to understand that when inflation stays high for a long time, it can potentially erode your ability to secure your future financial independence goals if you do nothing to prepare for it today.
What is inflation?
So, what is inflation? Simply put, inflation measures the rate at which prices change for goods and services you spend money on.
For example, if a pound of apples costs $1.05 today, when it was $1.00 twelve months ago, we can say that inflation has caused the price of apples to change by 5% over the past year.
Inflation is the rate of change, or speed, at which prices rise over time.
Whether you're aware of it or not, inflation is always around. The price you pay for the things you need or want is constantly in flux. It can rise and fall daily, weekly, or monthly.
It's like a car traveling down a highway.
Sometimes, inflation moves along steadily for months or years, like it's on cruise control traveling at the highway speed limit. It can also suddenly speed up over days and weeks when something causes the gas pedal to hammer down.
What truly makes it a matter of concern now is how quickly inflation has sped up and how long it has remained in high gear.
How does inflation affect purchasing power?
Inflation matters because the longer it remains in high gear, the fewer goods or services your money will buy tomorrow.
Economists call this declining purchasing power.
For example, a dollar in the late 1990's purchased one gallon of gasoline. Today, with gas prices around $5.00 per gallon, a dollar today has a fifth of the purchasing power it did over two decades ago!
A dollar is still a dollar, but it doesn't go as far as it used to. At least for gasoline.
And when inflation takes off, you need more dollars to buy the same product compared to a month or year ago.
That's why if you're setting money aside for a big-ticket purchase or plan to live off your savings sometime in the future, you need to be able to anticipate rising prices.
Indeed, understanding purchasing power is essential whether you're socking money away in a 401k to retire later in life or dependent on your savings now to cover retirement living expenses.
When inflation goes up, and purchasing power goes down, you'll likely need to either save more money today, spend less in the future or do a bit of both. Otherwise, you could find your financial independence plans falling short.
What causes inflation to speed up?
Just like a car needs gas to power its engine and a driver to raise or lower their foot on the gas pedal, no one factor causes inflation to accelerate or decelerate.
Inflation is an interplay between supply (amount of gas in the tank) and demand (driver's willingness to push down on the accelerator).
A full gas tank (supply) won't make a car go fast with a cautious driver (demand) at the wheel.
Likewise, an aggressive driver can only go so far with fumes in the tank.
Let's look at gasoline prices as an example. While some may argue that high prices at the pump are related to oil company profits, there's more at play than pure greed.
From a supply perspective, the fact is that economic sanctions on Russia has led to oil shortages in the West.
At the same time, key oil refiners have shut down because of fires, needed repairs, or maintenance.
From a demand perspective, summer is the travel season. And as more cars get out on the road and air travel picks up, so does oil usage.
When supply is limited, and demand is high, prices tend to go up.
Buying a house is another example. Demand for new homes increased nationally during the pandemic as individuals moved to the suburbs to work from home.
It typically takes about a year or so to build a new home, making supply an issue when thousands of individuals are looking to buy a home simultaneously.
Again, when demand is high, and supply is limited, prices tend to go up.
What role does government money play in inflation?
Now, some people will blame the government for today's high prices.
They'll argue that if the Federal Reserve (Fed) hadn't increased the money supply by printing trillions of dollars, or if it had raised rates sooner and the Treasury didn't send out stimulus checks, we wouldn't be dealing with high rates of inflation today.
To a certain extent, this is a valid argument.
Easy central bank policies arguably made it easier for banks to lend money, thus increasing demand from individuals willing and able to make large expenditures, like a new home or car.
Stimulus checks also made it easier for people to purchase goods or services they otherwise may not have needed during the pandemic, thus increasing demand at a time when economic lockdowns constrained global supply chains.
While this argument makes for a simple explanation, the truth is that the story is much more nuanced than can be explained by any one government policy.
That's because the rise in food and energy prices today arguably has less to do with interest rates or government stimulus than it has to do with supply. While government policies have added to the demand side of the equation, the supply of raw materials and finished goods sourced from around the world is still in short supply.
It's not just the government's fault. To be sure, today, we're dealing with a perfect storm of artificially too much money chasing artificially too few goods.
What can be done about inflation?
So, if inflation is seemingly speeding out of control, can't someone stop it? The truth is, there's only so much the government can do to halt inflation.
The Federal Reserve has raised its policy rate in a bid to slow down demand by making money more expensive to borrow and thus slowing the economy. But with war raging in Ukraine, ongoing Covid lockdowns in China, and other challenges, supply-side challenges likely will keep inflation elevated until those issues are resolved.
Fortunately, some businesses have raised wages to help workers offset higher living costs. However, most firms are not entirely altruistic, making up for higher wages by raising the price of their goods and services. This behavior could introduce an entirely new complexity to the inflation discussion. But, that's a topic for another day.
Three things you can do about inflation
For now, inflation matters because it can affect your ability to maintain your standard of living now and into the future.
There's not a lot we can do to affect the declining purchasing power of a dollar. However, you can mitigate its effects by:
1) holding just enough cash to help you sleep well at night,
2) putting excess cash to work in assets that move with inflation and
3) ensuring that you're saving and growing enough money today to make up for a declining purchasing power in the future.
Hold just enough cash to sleep well at night
Setting cash aside during this time of economic uncertainty is essential to weathering a financial setback.
However, keeping too much cash on hand could leave you with a reduced purchasing power of your savings.
For example, let's assume that you have $10,000 in a savings account that pays you interest of 1.00% per year. We'll also assume that inflation averages 5.00% over the year.
How much purchasing power do you have at the end of the year? If you said $10,100 you'd be wrong.
While you earned $100 in interest, inflation reduced your purchasing power by $500, with inflation running at 5% during the year.
That's why if you want to preserve the inflation-adjusted value of your savings, you'll need to put it to work in assets that can protect your purchasing power.
Put your money to work in productive assets
Where else can you put your money if a savings account alone won't protect against inflation? Consider your investments.
A diversified investment portfolio has historically been shown to be a hedge against inflation. Why?
Well, a key reason being is that the price paid for a stock today is often in anticipation of the underlying company's future earnings potential. And with firms increasingly passing rising costs on to consumers, corporate earnings have the potential to rise with inflation over the long term.
At the same time, bondholders demand a return on their investment that will compensate them for their time, investment risk, and inflation.
While stocks and bonds offer a degree of inflation protection, consider holding a mix of these assets in a diversified portfolio to reduce investment risk.
Ensure that you're saving enough to account for inflation
Finally, to our earlier point, inflation could leave your retirement savings goals falling short if not adequately accounted for. Indeed, if you want to secure your future financial independence when inflation is on the rise, you'll likely need to evaluate whether you need to save more money, reduce your spending or do a little of both.
Let's look at an example of how higher than expected inflation could alter the size of your retirement savings nest egg:
We'll start with a base set of assumptions that at retirement, you'll need roughly $50,000 per year to cover living expenses for the next 30 years. We further assume 2.0% average inflation and 5.5% average portfolio returns throughout retirement. At this rate, you'll likely need to have saved one million dollars to cover your costs.
What happens if inflation comes in faster than 2.0%? Well, if inflation turned out to average 4.0% instead of 2.0% over your 30 years in retirement, your million-dollar nest egg could go to zero in just over twenty years instead of thirty years.
To overcome this shortfall, you'd likely need to save an extra $280,000 before retiring, reduce your retirement spending by $10,000 annually or delay retiring by six years.
That's why periodically revisiting your financial plan and clearly understanding the effects of inflation on your expected future income need is essential to maintaining your standard of living and not running out of money in retirement.
Make no mistake, inflation can be a serious threat to your financial independence plans as it reduces the purchasing power of your savings.
Understanding the effects of rising inflation, putting your money to work in productive investments, and formulating a game plan to address declining purchasing power is essential to securing financial independence.
If you do nothing to mitigate this inflation threat, you could find your savings falling short of your desired standard of living later in life.
What is Lifestyle Creep + 4 Ways to Avoid it
Lifestyle creep is something that’s simple to define, easy to see, yet hard to avoid. Especially prevalent amongst young professionals, lifestyle creep is a hurdle many face in saving for their short- and long-term goals, like retirement. Below we’ll discuss what exactly lifestyle creep is and four ways you can work to avoid it.
What Is Lifestyle Creep?
Lifestyle creep is the idea that as your income rises, so does your spending. It’s often a naturally occurring financial issue, typically taking place gradually over long periods of time.
For example, if someone’s yearly salary rises from $40,000 to $50,000, they may be inclined to eat out more, take an extra vacation, update their wardrobe, move to a new apartment, etc. The problem with lifestyle creep is the lack of putting that extra income toward retirement and spending it all instead. That means that while someone is earning more, they’re not saving more.
Four Ways to Avoid Lifestyle Creep
If you’ve fallen victim to lifestyle creep, you’re not alone. And there are ways in which you can work to combat this financial phenomenon year-after-year.
Way #1: Compare Your Personal Inflation Rate to the CPI
An effective way to figure out if you’ve succumbed to lifestyle creep is to figure out your personal inflation rate and compare it to the Consumer Price Index (CPI), which is the inflation rate set by the government.
Take a look at your spending from last year. Say, for example, that you spent around $60,000 last year, and this year you spent around $65,000. Your personal inflation rate from last year would be 8.2 percent. If the inflation rate from last September to this September was 1.5 percent, we can easily see your spending is well beyond simple inflation adjustments. That’s a pretty big sign that you’ve experienced lifestyle creep.
Way #2: Make a Budget
The big thing to understand about lifestyle creep is that it’s different for everyone because it’s all relative to how much you make versus how much you keep. If you’re increasing your spending significantly but still putting a sufficient amount away towards your savings and retirement, then you aren’t outspending your earnings. A good way to do this and avoid lifestyle creep is to make a budget. Building a budget and tracking your spending is an eye-opening way to see where all the money is going and how easily small purchases can turn into significant spending.
Way #3: Plan For Your Next Promotion
Seeing your paycheck increase significantly after a promotion or salary increase is exciting and exhilarating. But if you go into a significant salary increase without a plan, that extra cash could start burning a hole in your bank account. Before temptation strikes, come up with a game plan for your new earnings. Decide what percentage of your increase you’ll be putting directly into savings and how much you’ll be leaving as new discretionary income. Move forward with your plan as soon as the increase goes into effect, making the transfer into savings automatic if possible. This way, you won’t even have to decide month after month whether to save or spend.
Way #4: Don’t Forget to Enjoy Your Earnings
You work hard for promotions and salary increases, and you should get to reap the reward of your efforts. Don’t try to deprive yourself completely when you receive a pay increase, especially when you’re creating a new budget that’s adjusted for your new salary. Give yourself a little wiggle room to spend, and practice spending with intention. For example, instead of making a couple of impulse purchases here and there, save that extra money to spend on a weekend trip with your loved one.
Lifestyle creep can occur so effortlessly that you don’t even know you’ve experienced it until you look back and assess your previous spending. And while receiving more money month-after-month is exciting, the key is to focus on saving what you need to for retirement and other large financial goals before spending your extra earnings.
Are Your Financial Goals Meaningless?
Most driven individuals on their path to financial independence mastery know that you need goals to get to the next stage in life. And when it comes to money, many individuals have plans to increase their earnings ability, improve their lifestyle or save for long-term financial security. Nevertheless, even the most ambitious individuals quite often find that their goals fail within weeks or months into their endeavor. Why? Because they set meaningless goals.
So, what is a goal? A goal is a future or the desired result that you envision, plan for and commit to achieving. Many well-intentioned individuals set specific, measurable, actionable, realistic, and timebound (or SMART) goals. And goal-setting can be as simple as striving to wake up at 4 am each morning to exercise for 15 minutes so you can lose five pounds in a month or as ambitious as starting a business from the ground up.
When viewed in isolation, a well-defined financial goal may appear virtuous or valid on its surface. But, when it's out of context with what's essential to you, your goal likely will become meaningless and fail because it's not aligned with what matters most in your life. Certainly, determination to achieve an objective may initially propel you towards your aim, but soon enough, willpower fatigue likely will set in, and you'll probably end up reverting to old financial habits.
Alternatively, you could push toward your financial goals on willpower alone, mistaking effort and progress as measures of success as you propel forward only to find that the object of your intention is hollow or unappealing once you've attained it.
Goals in and of themselves are meaningless. They're simply a means to an end. What gives a goal meaning is its transformative power to shape and change who you are so that you can have the resources you need to experience a life worth living.
Why Do People Set Meaningless Goals?
So, why would someone set out to pursue a meaningless goal? Well, some individuals attain disappointing outcomes because they fail to take the time to understand what they want from life before creating and getting after their dreams. Thomas Merton, an American Trappist Monk, once said that "people may spend their whole lives climbing the ladder of success only to find, once they reach the top, that the ladder is leaning against the wrong wall." In a similar vein, Steven Covey was quoted to say that "if the ladder is not leaning against the right wall, every step we take just gets us closer to the wrong place faster."
In his book, The Second Mountain, David Brooks uses the analogy of climbing a mountain to pursue goal fulfillment. Some individuals start out in life intending to scale a mountain summit to reach some level of material wealth, comfort, or simply to be "happy". After speaking with hundreds of people from all walks of life and studying philosophy, religion, psychology and sociology, Brooks' findings show how even the most accomplished athletes, artists, business leaders and many others struggle with drugs, alcohol or other vices to make up for the hollowness of their lives even after acquiring status or wealth that many in society today would yearn for.
Whether you view goal setting as climbing a ladder or summiting a mountain, the fact is that if you haven't clearly defined why you're pursuing the goals you've set out for yourself, a time likely will come when you end up with frustration and regret. Indeed, a time could come where everything you have achieved will seem as though it were for nothing. And to be sure, society today is littered with broke lottery winners, miserable millionaires, and accomplished actors and musicians who have ended their lives in desperation.
The truth is that many well-intentioned individuals chase meaningless goals not because they're sadistically pursuing failure. More often than not, this outcome has to do with the fact that their goals were not their own. They're just doing what seemingly everyone around them is doing or wants them to do.
This behavior typically occurs when we live a financial script handed down from family or culture early on in life, like going to school, getting a good job, buying a house, getting married, having kids, and saving for retirement. It's keeping up with the Jonses or living the American Dream, right? Well, when you're setting goals to live someone else's financial scripts, there's a good chance that you could wake up lost, disappointed, or simply unfulfilled. So how can you set meaningful financial goals?
The Antidote for Meaningless Goals
First, start by understanding what's essential in your life, define a vision that aligns with your values, and then create goals that align with your vision. Isn't this all fluff when we should be talking about making money? The short answer is no.
Make no mistake, the word "vision" seems like another fancy buzzword because it's become so overused in today's culture. That's why when you hear the word "vision", you might think of business leaders who are intent on using ten-dollar words like "vision statements" to represent ten-cent ideas or self-help gurus who espouse having vision as a panacea for overcoming personal or professional underperformance.
But the truth is that in its simplest form, the word vision represents a picture or a snapshot of your desired life destination. It's the creative process of developing a mental movie of your future potential life outcome. Vision is about being clear about where you're heading; goals are how you get there. That's why without vision, goals are meaningless.
Now, you may be asking: "Isn't vision and goal the same thing?" You might even ask, "I envision myself having saved more money in ten years than I have today; isn't that a vision." Well, vision is different from goals because it marks what happens after you've crossed the finish line. If your goal is to have more money in ten years, how would you use that money? What would change in your life as a result of having acquired more wealth? A goal, like saving more money in the coming ten years, sets out a specific set of tasks necessary to accomplish that outcome. The vision, on the other hand, is what you will do with that money and how your life will change once you have that money in your hands.
What Does Vision Look Like?
If you're still trying to wrap your head around the concept of vision as it relates to your finances, take an example from Pele. Now, Pele is arguably one of the greatest soccer players in the world. And he attributes his success to the practice of visualization. If creating a vision is imagining your future life outcome, then visualization is the active practice of rehearsing that story in your mind. That's why one hour before each game, Pele would go through his own mental movie, starting with when he was a child to his current moment right before a game, recalling how he felt playing soccer as a child and how he needed to play his next match as a way and to evoke positive emotions and mentally prepare himself for success on the field.
Thinking more long-term, some individuals find it helpful to create vision boards by physically laying out pictures of places, people, or destinations they'd like to see take place in their lives. Now, to be clear, we're not talking about the "law of attraction" or positive thinking type of board here. Simply put, it's a physical board filled with a collage of pictures representing how you'd like to see your career, family, health, travel, or social situation play out in the future. The collage itself is a physical representation of your intentions. It's there to remind you why you're getting up in the morning. You're still going to have to get at it and do the work to make that vision a reality!
At first glance, your initial response may be to say, "What's the point in all of this? I'm not looking for some path to enlightenment here. All I want is to save enough money to buy a house, put my kids through college and ensure that there's enough money to cover my needs for the rest of my life." Now, this is a valid point, but how much money is enough? Let's assume for a moment that you've accomplished these goals. Then what? Well, take a tip from Disney. No, not Walt Disney. We're talking about his brother Roy.
When we think of Disney, more often than not, we think of its founder, Walt Disney, the creative mind behind the media company. Few people know, however, that it was Roy who was the operations genius that turned the company into a profitable empire. And Roy once said that "when your values are clear to you, making decisions becomes easier." Put differently, when you're clear about where you're going and understand what the destination looks like, you instinctively know what goals need to be set and the resources you'll need to achieve that result.
Intention: It's What You Need to Create Your Vision
So, how do you create your life vision? To know what you want your life to look like, you'll first need to take the time to understand what's important to you and how you want to spend your time. This journey begins by identifying your top core values. In his book, Atomic Habits, author James Clear shares a list of values he prepared in collaboration with the LeaderShape Institute.
In his book, Clear describes how he identifies five core values to focus on and then prioritizes the short-list. After that, he aligns his daily practices to align his life with his values. Once you've identified which values you want to give your time to, then take the time to create a vision for how your life will change in the future as you begin to focus on your priorities.
Again, vision represents a picture, or a snapshot of your desired life destination. It's the creative process of developing a mental movie of your future potential life outcome. Vision is about being clear about where you're heading, goals are how you get there. This brings us to our final point: setting your goals.
Goal setting is the process of identifying what work needs to be done, the financial resources you need, and who you need to become to close the gap between where you are today and your ideal life vision. When approached correctly, this goal-setting process should withstand the ebbs and flows of near-term uncertainties when they're grounded in your vision and values.
When it comes down to it, spending the time to create your vision is an act of intentionally designing your life. The truth is that few individuals want to take the time to be introspective. They want a quick fix or rely on others to tell them how to do it. But if you want to avoid pursuing meaningless financial goals, you'll have to start by doing the work to understand who you are, what's essential to you and then creating a vision for how you want your life to unfold. Doing so will naturally lead to creating meaningful goals and move you further down the path to mastering your financial independence journey.
Finances: The No. 1 Reason Americans are More Anxious Than Ever Before
As we get older, more and more expenses end up on our plate. From mortgages to car repairs, it can feel like there are endless bills to pay. And as we all know, with more bills, comes more pressure, anxiety and stress. In fact, the American Psychological Association found that money is Americans’ number one stressor.1 Finances have remained at the top of the list since the survey began in 2007.2
When it comes to stress, the numbers don’t lie. The Proceedings of the National Academy of Sciences conducted a study that evaluated heart health changes before, during and after a recent financial crisis and found that during the recession, both blood pressure and blood glucose levels increased in respondents, signaling a worsening in heart health.3
While many of us dream of being financially secure, most of us can agree that traditional education in our public schools does not properly equip us with the knowledge and resources necessary to be effective financial decision-makers. There seems to be a growing gap between financial literacy and our population, causing many people to lose hope and get trapped in a deeper hole of debt. However, when it comes to money, there are four ways you can more effectively manage your finances so you remain in control of your spending habits.
Tip #1: Automate Your Savings
It can be difficult to set aside money every month, especially after you’ve been anxiously awaiting to get your paycheck. If you’re someone who struggles with putting money away, consider setting up an automatic transfer from your checking account to your savings account each month to make sure that no matter what, you’re continuously growing your nest egg. Whether you want to be prepared for any emergencies that may come up or have a dream of buying a house one day, adding money to your savings account every month — even if it’s only $100 — can get you closer to the financial stability you need to feel confident about your future.
Tip #2: Stay Away from Impulse Purchases
With so many products out there — ranging from new gadgets to the latest must-have accessories — it can be difficult to put a cap on your spending habits. Instead of putting yourself right in front of your guilty pleasures, consider putting your money towards experiences, rather than material items. If your favorite past-time is going to the mall, swap window shopping with a picnic out in the park or a day out at your local museum (some museums offer discounted prices over the weekend). While retail therapy may seem like the solution to your problems, oftentimes, you end up feeling worse than if you had spent your time making memories instead. With these memories, your craving for consumerism may gradually die down, leaving you with more time to enjoy the simple pleasures in life.
Tip #3: Focus on What You Can Control
While it’s difficult to effectively plan ahead for every single expense we’re going to have, you can at least have an initial game plan for where your money is going to go. Theoretically, every month, you know you’re going to have to pay rent or a mortgage, buy groceries, pay other utility bills and fill up on gas a few times. So, after you get your paycheck, subtract all of these expenses from your total amount. This will give you a clear idea of how much “fun” money you have to spend each month. And, if you plan to put some money into your savings account, you’ll want to make a note of that too. The purpose of this exercise is to make yourself more mindful of the money you’re spending each month. When you know — without a doubt — certain specific expenses are going to come up, you can start planning ahead to make sure you’re not spending more money than you have.
Tip #4: Be More Goal-Oriented
For some people, the thought of having a goal can be terrifying as it means there is a chance they might fail. However, if you never set goals for yourself, you’ll never have complete control over your financial life. To get started, begin with a realistic goal that can ideally be achieved in less than five years, such as paying off your credit card debt or student loans. Once you’ve identified what you want to accomplish, write it down.
Oftentimes, the simple act of writing down your goals can make it feel more real, therefore making you more accountable. Next, create a rough timetable of how you are going to achieve your objectives. This timetable could include information such as how much money you’re going to save every month, as well as milestones for each payment you’re going to make. Over time, you’ll begin to gain more confidence about your finances, in turn leaving you feeling more in control — and capable — of managing your money on your own.
- https://www.apa.org/news/press/releases/2015/02/money-stress
- https://www.marketwatch.com/story/one-big-reason-americans-are-so-stressed-and-unhealthy-2018-10-11
- https://www.pnas.org/content/115/13/3296
Another Recession is Here. Now What?
It's unofficially official: we're in an economic recession for the second time in two years. At least, that's according to government data published this week.
This news comes from the Bureau of Economic Analysis' latest report on economic activity, which showed that U.S. Gross Domestic Product, or GDP growth, contracted during April, May, and June, marking the second straight quarterly decline so far this year.
And by some measures, two consecutive contractions in GDP is considered the start of a recession.
What is a Recession?
So, with all of this talk about a recession, some of you may be asking, “what exactly is a recession?” Well, as of late, there's little consensus as to the definition of a recession. In fact, the White House has been working hard this week to redefine what it means to be in a recession. Nevertheless, a recession can be defined as simply a decline in economic activity over some time.
And it's important to keep in mind that recessions are not caused by a single event, but instead occur as a result of many factors, including rising interest rates, higher inflation, declining consumer spending and investment, falling production capacity and rising unemployment.
Now, our country has been through 48 recessions since its founding. And since 1947, when government statistics were gathered more consistently, data show that we've been through about twelve recessions in the past 75 years.
Of those twelve recessions, ten of them have occurred when two quarterly GDP declines were in place. So, from this perspective, if we use history as our guide, we could safely say that a two-quarter decline in GDP growth is consistent with a recession.
So, Are We in a Recession?
Now, it's important to note that while we've experienced two consecutive declines in economic growth, the official measure of a recession is often broader than looking at GDP alone.
To be sure, the National Bureau of Economic Research, or NBER, considers several indicators before officially calling a recession. They look at what’s going on in the labor market, consumer spending, industrial production, and other measures before calling slowing growth a recession.
While some of these indicators have softened recently, they’re generally in what appears to be still positive territory. With that said, if we look back to the Great Recession, we find that while the NBER called the recession starting in December 2007, industrial production didn’t roll over until April of the following year.
We can even go back to the recession of 2001 around the Dot Com bust to find that there’s no singular measure of a recession. For example, while the NBER called a recession starting in March 2001, GDP did not even go through a two-quarter contraction during this period. Nevertheless, U.S. economic activity did experience a decline broad enough to have been considered a recession.
With all that said, the NBER does not have a track record of calling recessions in real-time, and often they confirm their findings only months after a recession has already begun or ended.
So, are we in a recession? Well, the short answer to this question is likely yes.
While the NBER hasn't officially come out and called a recession yet, there's a solid reason to believe that we may be in one today. Again, over the past 75 years, there's been a couple periods where the economy experienced a two-quarter decline, and a recession did not occur, and that was in 1947.
Since then, every recession has been accompanied by a two-quarter decline in GDP like we've experienced so far this year.
How Does a Recession Affect Me?
Now, given all the headlines surrounding recessions, you might wonder how today's current events affect you.
Well, how a recession might affect you depends on your situation and where you're at in your financial independence journey.
If you are in the accumulation phase, saving money and preparing for your definition of financial freedom, you may have some obstacles to navigate in the months ahead. For instance, layoffs tend to rise during economic downturns, so having an emergency cash reserve on hand to deal with a potential unemployment situation will be essential to navigating this period of economic uncertainty.
With that said, if your emergency savings are topped up, and you're feeling confident about your current job prospects, then a recession might provide you with an opportunity to buy financial assets at a discount or invest in distressed real estate or other business ventures as the economy weakness.
Now, you'll likely find yourself with a unique set of challenges if you're an individual in the distribution phase of your financial independence journey. For example, market pullbacks or bear markets often accompany recessions.
And by many measures, we're already in a bear market today.
So, if you're currently dependent on your investment savings to cover living expenses during retirement, then taking distributions from your portfolio when prices are down could mean locking in market losses at an inopportune time.
If you've been following along with our commentary over the past few months, however, then you'll likely know how imperative it is to have an adequate cash reserve to cover 12-18 months of living expenses during this time.
This cash buffer can allow you to maintain your standard of living even during a recession-induced bear market, while giving your portfolio enough time to recover once the economic outlook clears up.
While recessions can be devastating to individuals, businesses, and the economy at large, they are not always a bad thing: when the economy contracts it means financial resources are being allocated more efficiently. And this can help to correct imbalances within the system, especially after an extended period of loose monetary and fiscal policies and free-wheeling market conditions.
Fortunately for most people, it's possible to weather even severe economic downturns as long as you're prepared financially and emotionally.
Preparing for a Recession: Start with Your Plan
So how should you position your finances for weaker economic growth and heightened market volatility in the months ahead? Well, if you're an individual focused on mastering your financial independence journey, the short answer is to stay committed to executing on your long-term financial plan.
During times of economic and market uncertainty, for some of us, there's a tendency for our vision to narrow to the present, tempting us to change the way we handle our finances or investment allocations as a way to mitigate what appears to be an immediate financial threat.
Even so, if you have a well-structured financial plan and a disciplined investment process already in place, then the action that you'll likely need to focus on today is consistently doing the work necessary to execute your plan.
To be sure, if you have a well-crafted financial plan already in place, then those actions should be defined in your implementation schedule. Otherwise, developing a set of strategies to align your financial resources with your long-term goals should be a priority if you don't already have a comprehensive financial plan in place.
Certainly, a solid financial plan lays out how to connect the dots between your financial resources and ideal long-term lifestyle goals. At the same time, it identifies predefined strategies and tactics that you can tap into to manage adverse conditions when they inevitably arise in the near term.
Have Adequate Cash on Hand
Once your financial plan is in place, the next thing you'll likely need to focus on is getting back to the basics.
What do we mean by getting back to the basics? Well, what we mean here is ensuring that you have enough cash on hand to weather the impending economic storm, whether you're dependent on a job or a retirement nest egg to cover your household income needs.
When it comes to managing your portfolio during a recession, there's no substitute for cash. Sometimes it can be hard to get excited about cash, but in a recession, having some money in reserve can save your investments and keep their value whole while waiting out the downturn.
Cash is also necessary because it's a great way to rebalance your portfolio back toward its original goals if something causes some of your investments to perform poorly (which often is inevitable!).
Having cash on hand to be able to buy more shares of one security or another when prices decline may enable you to take advantage of opportunities and spread risk across various asset classes. This is one reason why we advocate for maintaining investment exposure across stocks, bonds, and real estate in both U.S. and international markets.
Assess Your Current Portfolio
The next step for investing during a recession is to get a good picture of your current portfolio. What's in it? How much risk are you taking? What are your investment goals, and how much risk can you stomach?
Now that you have a good understanding of where you stand, think about how to protect yourself during an economic downturn.
Don't Panic and Don’t Sell Everything
One essential way to safeguard your investment portfolio is to protect it from yourself. While headlines will focus on the negatives that recessions often bring, you'll likely need to remember that this is not the end of the world—it is just a temporary setback.
You likely already went through this back in 2020 and made it through in one piece.
Certainly, no one can predict what will happen next, but if you sell everything now, you may be selling at a loss and will regret it later.
Another Recession is Here. Now what?
When it comes down to it, various indicators suggest that we're likely already in a recession. And this time around, the government likely won't be ready to cut checks and support the economy as it had in the past.
That's why if you're serious about mastering your journey to financial independence, then now's the time to ensure that you have a solid financial plan in place, that your investment strategy is aligned with your long-term plan and that you're effectively executing on your implementation schedule.
If you are afraid of losing money in your investments, don't panic and sell everything; instead, get some professional advice from someone who knows what they're doing.
Most investors get through downturns just fine if they have a little patience and a good strategy.
Many investors who lost money during the Great Recession or during the Pandemic did so because they didn't have a diversified portfolio or got out of the markets altogether.
And there's no such thing as a perfect investment strategy. But if you have a plan and stick to it, you'll be in better shape than most.
If you've been through a recession before, you know how difficult it can be. But if you have a solid strategy and stick to it, it doesn't have to be all that stressful. The key is to have enough cash on hand to navigate market and economic uncertainty.
And again, stay calm and don't panic sell your investments just because there's bad news out there! Remember: recessions come and go. But over time, they can provide tremendous buying opportunities and allow the value of a diversified portfolio tends to go up in value over the long-term if bought at reasonable prices.