5 financial lessons learned during the pandemic
As the world continues to struggle with the financial and economic fallout of the COVID-19 pandemic, there’s no question that it has served as a financial wake-up call for many. Even those who will emerge relatively unscathed from a financial perspective have not escaped the worry and anxiety that accompanies living through challenging times. And like most of life’s challenges, there are lessons to be learned. Below are five financial lessons we can take away from this unprecedented period and use to strengthen our financial footing in the months and year to come.
Lesson 1: You always need a safety net.
One thing the pandemic has made clear is that even those with seemingly reliable income streams—including some of the most essential workers during a health crisis—were not immune from income disruptions. According to the U.S. Bureau of Labor Statistics, a record number of nurses and healthcare workers have lost their jobs during the COVID-19 pandemic as hospitals halted revenue-generating elective surgeries and routine procedures. In April alone, 1.4 million healthcare jobs were lost.
Income disruptions, whether from a job loss, furlough or reduced hours can have far-reaching implications, from the ability to meet your essential needs for food, housing, clothing, and transportation, to your physical health and well-being if you can’t afford healthcare premiums or the co-payment for an emergency room visit.
Retirees aren’t exempt either. Many without adequate cash reserves in the first half of the year had some tough decisions to make. Continue to pull money out of the market for monthly expenses and risk cementing losses, or try to get by on Social Security alone? Those with a pension, in addition to Social Security, were in better shape, although the number of retirees receiving pensions continues to decline.
Yet, during the 10-year bull market that predated the COVID-19 pandemic and the economic crisis that followed, it was hard to convince some investors to retain six months of living expenses in cash reserves. The push back was that the money wouldn’t be working hard enough for them outside of the stock market, due to the low interest rate environment.
While the pandemic has provided a dramatic example of why emergency savings are important, keep in mind that unexpected events, including job losses and medical emergencies, can happen even in the best of times. The general rule of thumb for emergency savings is to set aside three to six months’ worth of living expenses. Your advisor can help you determine how much you may need, based on your personal circumstances and lifestyle goals.
Lesson 2: The combination of high credit card debt and low savings leads to financial fragility.
A recent CreditCards.com survey, reported that 23% of U.S. adults (approximately 120 million Americans) with credit card debt have added to it during the pandemic. When respondents were asked about their payoff strategies, 60% said they would pay more than the minimum, while a combined 13% either don’t plan on paying anything (9%) or don’t have a plan at all (4%). Seven percent said they would try to negotiate with the card issuer. While many credit card issuers are offering various types of financial relief programs during the coronavirus pandemic, they often come with long-term costs since many cardholders will continue to see interest accrue.
A better approach for many may be to simply take out a personal loan to pay off credit card balances in their entirety. Data from the Federal Reserve shows that, in the first three months of 2020, borrowers with credit card debt were charged an average interest rate of 16.61%. Meanwhile, those who used a personalized loan to consolidate debt were only charged interest at a rate of 9.63%, which is considerably lower. That marked the biggest spread between credit card and personal loan interest rates since the Fed began tracking this data in 1998. With loan rates significantly lower than credit card interest rates, if you were to use a personal loan for debt consolidation, you would save on interest, which would not only lower the total amount that you end up paying over time, but help you to pay down your debts faster.
Lesson 3: Market losses require a disproportionately higher gain to return to breakeven.
While this is hardly a new principle, the concept may be new to many younger investors whose only experience investing may have been during the recent, extended bull market. However, it’s also an important concept for those in or nearing retirement to understand since they face shorter timeframes when it comes to recouping losses.
A steep drop in portfolio value, like we saw in March of this year when the S&P 500 plunged 34%, can take a significant amount of time to recover from, even when the market quickly rebounds. That’s because recouping market losses requires a disproportionately higher percentage gain to return to breakeven. For example, let’s say you lost 20% on an investment of $100. The value of that investment would drop to $80. A subsequent gain of 20% would only bring the value of the investment to $96, not the $100 you started with (20% of $80 is $16). To get back to the $100 you started with would require a 25% gain. And remember, that only gets you back to breakeven. Depending on market conditions, it can take weeks, months or even years to recoup stock market losses. So the goal is to avoid unnecessary losses in the first place.
While market fluctuations create value over time, you want to make sure that the amount of volatility you’re exposed to is aligned with your personal risk tolerance and the timeline you’ve established for your various financial goals. This is why a strategy that focuses on risk-adjusted returns is so important. Basically, you want to achieve a balance between the level of return an investment provides with the amount of risk exposure you’re willing to accept. At the beginning of this year, many investors who thought they could stomach a 15% or 20% drop in the markets quickly found out that they really couldn’t when the stock market dropped in March.
Lesson 4: Regular portfolio rebalancing matters.
Many investors who didn’t rebalance their portfolios and harvest gains on a regular basis during the extended bull market also learned in March that they had greater exposure to market volatility than they had intended. As a result, many experienced more severe losses than they otherwise would have. That’s because, over time, market swings can throw your target allocation out of alignment with your goals and risk tolerance. When that happens, you can rebalance by moving money from investments that take up a greater portion of your portfolio than desired into those that could use a boost—to get back to your target allocation.
During the recent bull market, many investors put off rebalancing as their portfolios continued to go up in value, only to end up being exposed to more risk than they intended. For example, if you were comfortable with a portfolio comprised of 60% equities at the start of the bull market, your portfolio may have crept up to 80% in equities ten years later, if you didn’t take time to rebalance. The danger there is that now you’re 10 years closer to retirement than you were, which means you have less time to recover from losses. However, if you had harvested some of the appreciation through regular rebalancing, you would have potentially lowered your exposure to the volatility we’re experiencing in today’s markets.
The good news is that it’s not too late to rebalance and realign your asset allocation to pursue the level of risk-adjusted returns you desire going forward.
Lesson 5: Get rid of the “stuff” that’s weighing you down.
Perhaps one of the most profound lessons from the pandemic is clarifying what matters most in our lives. While that varies from person to person, one common thread—at least based on data compiled by Goodwill Industries and The Salvation Army—is that most of us can live with less stuff in our lives. Both organizations saw a surge in donations this spring and summer as Americans tackled closet cleaning to help stave off the boredom of weeks, or in some cases, months spent at home. For some, it was simply a long overdue task. For others, there was something deeper at play—a need to re-evaluate priorities.
It often takes a critical event or shift in our lives to refocus on what really matters to us—what serves a purpose in our lives and helps us to move closer to our goals. Whether your goal is to put your physical or your financial house in order, discarding the things and habits that no longer serve you can be transformative. If you’re looking to eliminate paper clutter, and the need to store documents in boxes or files, consider going paperless and electing digital receipt of account statements, trade confirmations, prospectuses, and more.
As I mentioned earlier, debt can also weigh you down. If you want to eliminate credit card debt, begin by tackling your high-interest debt first. Once you’ve eliminated your credit card debt, you’ll no longer be paying the interest charges for the debt. Instead, that money can be used to shore up your emergency fund. This enables you to replace something that is not serving you well—debt—with a new habit that does serve you well—saving.
Finally, consider your financial relationships. Are you working with an advisor who places your best interests first? How often has your advisor reached out to you over the past six months to see how you’re doing or to reassure you that you’re still on track toward your goals? If it’s been awhile since your advisor has made contact, you may want to consider how much you’re really getting out of the relationship versus your advisor. If it feels more like a one-way street, it may be time to reconsider who you work with and why you’re working with them.
To learn more about maintaining financial preparedness during these unique times visit FirstMidwest.com