Weatherproofing your finances
“Never let a good crisis go to waste.” – Sir Winston Churchill
Over the past few weeks, I’ve been facilitating a number of education sessions and one topic that often comes up for discussion during Q&A is when we’re likely to see a downturn in the stock markets. While there’s no way to accurately predict when the next dip in the markets will be, if we look at it historically speaking, we know that on average, there are 3-8 “good years” between every downturn. Currently, we’re in our fourth year of good markets so it’s reasonable to assume that at some point in the next 3-4 years we’re going to see a bear market, but whether that will happen a week, a month or two years from now is impossible to predict.
Related article: Is it possible to predict movements in the stock market?
This element of uncertainty is what seems to bother people the most and that’s understandable. While there are definitely some people who thrive on the thrill of launching into the unknown, most of us tend to feel more comfortable when we know what’s ahead of us. The truth though, is that in finance and in life, there are many things that we can’t predict: the next downturn in the stock markets, when interest rates will rise, whether life will throw us a curveball that will impact our financial health, etc. etc.
Related article: Are you protected from financial curveballs?
We can’t predict these things but we can take steps to ensure we’re prepared to weather whatever storm life throws at us. Just like we weatherproof our homes and make sure the doors and windows are closed when we see the thunderclouds rolling in, so we can weatherproof our finances to make sure we’re in the best position possible to ride out the storm. Here are three suggestions on weatherproofing your finances:
Build a buffer
A 2007 survey found that 49% of Canadians felt they were only two paycheques away from poverty and a 2014 study found that 63% of Americans don’t have an emergency fund. Not having adequate savings is a surefire way to make a tough situation exponentially worse. This is why it’s so important to have a contingency fund. Experts suggest that having 3-6 months of expenses in an account that’s easy to access in an emergency (ie: not tied up in GICs or investments that could drop in value) is a good place to start. If missing one or two paycheques would put you in a position where you wouldn’t be able to pay your bills without relying on some form of credit then it makes sense to figure out a way to build your savings.
Stress-test your debt
Our interest rates are at the lowest they’ve been for years. This is good news for those of us carrying consumer and mortgage debt because it makes our payments more manageable. However, one question we should all be asking ourselves is, “if interest rates were 1-2% higher, how would that impact my payments and would I still be able to handle them?” For many of us, an increase of just 1% would put us under significant financial stress. Putting some serious effort into paying off as much debt as possible while rates are low not only puts us in a stronger position to handle the rise in interest rates when it comes but also gets us closer to financial freedom.
Related article: It’s important to stress test your debt
Invest within your comfort zone
Money is a very emotional topic and investors often make the mistake of letting their emotions take the reins when it comes to making investment decisions. No-one likes to see a drop in the value of their investments. However, too many investors are tempted by the higher returns of more aggressive investments while markets are strong and only discover they’re out of their comfort zone when the markets fall. Ask yourself what kind of losses you would honestly be able to stomach in your portfolio and then take a look at the historic lows of your investments to make sure they match your comfort zone. If you don’t ever want to see a drop of more than 10% and yet you’re invested in an aggressive asset allocation fund, you might want to consider investing in something that better matches your risk tolerance.
With any goal, it makes sense to look ahead and anticipate which obstacles could fall into our path. Some people use the obstacles they anticipate as a reason not to move forward; some use them as a reality check to make sure they’re as prepared as possible for the journey. In the same way that there’s no point replacing the roof once the rain is falling when times get tough, there’s no point looking back and checking off all the things we should have done. It’s too late. Right now, while markets are good and interest rates are low, it makes sense to take stock of our financial house and ensure that we’re as prepared as possible for any storms that roll in.