It’s hard to believe it’s been over a year since a global pandemic changed our lives, the reverberations of which have been a wake-up call in many ways. Many people don’t really focus on their finances until a crisis hits – when they are forced to.
Since we’ve passed the one-year mark, let’s reflect on some of the COVID financial lessons that may have really hit home in the past 12 months. Many of us have learned important lessons from the challenges in the past year that can have a positive impact on our lives and finances going forward. Now can be a good time to evaluate your overall financial picture and make changes so you feel more confident about the future.
Have an Emergency Fund
Numerous sources ranging from Forbes to the Associated Press recently reported that 69% of U.S. households have less than $1,000 in liquid savings in an emergency fund. It is so easy to skate by when things are fine, but when temporary shocks to your income occur, it really helps to have 3-6 months of expenses in a savings account that you can dip into instead of having to sell out of the market with potential tax consequences. While the funds may not cover long-term unemployment, they can help reduce the impact of shorter-term economic disruptions. Unemployment benefits typically take several weeks to arrive, and earlier in 2020 you probably recall the news that the layoff surge from the coronavirus overwhelmed many state unemployment offices, causing further delays.
Create a Financial Plan
As advisor Scott Adair recently discussed in his article Create a Good Financial Plan, Then Take Comfort In It, working with a professional to create a well-thought-out financial plan can help provide more peace-of-mind for those looking to safeguard their financial success. Charles Schwab reports that 72% of households do not have a written plan. One of the immediate benefits you gain from creating and having a financial plan through goal setting is more clarity and confidence. A solid financial plan involves managing not just your investments, but also your risks. Consider whether you have adequate insurance coverage, an up-to-date will and estate plan, too much high-interest rate debt, and the most appropriate asset allocation for your personal risk tolerance level. Consulting a professional can help you think about all of this and help point out any blind spots you may have missed.
Diversify Your Investments and Invest for the Long Term
Consider the importance of diversification of your investments. We were in the longest-running bull market in history – things just kept going up, up, up. It was easy to get lackadaisical and invest in tech stocks, high growth funds, etc. But when market volatility hits, you really see the effects of having a well-diversified portfolio or not. By putting a percentage of your assets in different well-balanced mutual funds or ETFs across a variety of asset classes, you lower the chance of one or multiple economic events wiping you out.
Stay invested in your investments long-term. There are few elements more important than the compounding you lose out on when the markets recover. Abandoning investments during a downturn may ease some anxiety, but you miss out on the comeback when it happens. Additionally, you often have unintended tax consequences and actual ‘realized’ losses when you get out of the market, as opposed to perceived losses when you are in panic mode because the numbers on your computer screen are dropping precipitously and the talking heads on television are telling you how dire things are. If the volatility of the last year felt like too much for you, then re-assess risk tolerance and adjust your portfolio accordingly.
The Value of Having A Financial Advisor During Volatile Times
Financial markets have always been and will continue to be volatile. While the ideal scenario is for security prices to continuously grow, that simply isn’t reality. However, as with any obstacle we face, finding opportunities until you come out on the other side is what will set you apart in the long run. Working with a trusted Financial Advisor can help you find and take action on opportunities available to you so that you can maximize your investments, even during a financial crisis.
Emotion plays a large role in our investing success and decisions, and it does not discriminate between amateur and professional investors. Market volatility can cause investors to make poorly-timed, emotional investment choices which often lead to disappointing results. As many of us experienced in 2020, watching a 30% unrealized loss in your portfolio in real-time is not for the faint of heart. It can be very painful to see the value of your hard work and discipline disappear with each passing day. A financial advisor who communicates proactively during a financial crisis will help you tune out the noise and stay the course, even when you feel like you can’t.
2020 was an excellent year to take advantage of Roth IRA conversions. With a down market and the waiver of required minimum distributions (RMDs), it was an ideal opportunity to convert retirement savings from traditional IRAs into Roth IRAs. Unlike a traditional IRA, qualified Roth IRA withdrawals are federal income tax-free. It’s advantageous to convert balances from your traditional IRA into a Roth IRA when markets and your account balance are down because you have to recognize income and pay income tax on the amounts converted in the year of conversion. A lower IRA balance will result in less income being recognized and taxed. Additionally, required minimum distribution (RMD) rules don’t apply to Roth IRAs, so you can keep earning tax-free income and gains in these accounts as long as you live.
There were also great opportunities for rebalancing and tax loss harvesting of portfolios last year. When the equity markets dropped, it was a great time to sell out of fixed income in order to buy equities at suppressed prices and get asset allocations back on target. Sticking to a long-term asset allocation that is right for you is key to success, and rebalancing is a useful tool to stay on track. Tax-loss harvesting is essentially selling off investments that are worth less than you paid for them. The goal is to reduce both your capital gains taxes on investments as well as your overall taxes. Any unused capital losses generated in a given tax year can be carried forward indefinitely to offset capital gains generated in future years.
Hopefully, at some point soon, things will begin to feel normal again and not ‘pandemic – normal’. Until then, from all of us at ML&R Wealth Management, take care and stay safe. If you have questions about any of these COVID financial lessons or any other topic, please contact us.
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