Challenging times become ever more so when they also affect your money. Times of uncertainty make us second guess many of the things we know to be true. The difficulty lies in the nearly endless barrage of 24/7 media coverage, which as we all know is almost never positive.
So how do we protect ourselves financially during this time? For starters, we want to avoid the biggest mistakes we can make during times like this. Here is part one of the list of the Big 5 mistakes investors need to avoid to keep their finances on track during times of trouble.
1. Stopping your retirement plan contributions. This one is particularly damaging because contributing during a decline is often the fastest way to recover what you have lost. If we look back to the financial crisis of 2008, it took investors on average 5 years to recover what they lost from the market decline. If those same investors were contributing to a retirement plan all along, that time was cut in half to only 30 months! Why? Because contributing during a decline allows you to make purchases when prices are lower, which reduces the overall costs of the investments you bought. For example, if you bought a stock at $100 and it lost 50% of its value, it’s now worth $50. If you bought the same number of shares at the new price of $50, then you only need the total investment to get back to $75 in order to break even. Anything above $75 is now a profit for you. On the other hand, you would have to wait for it to get back to $100 if you bought no additional shares at the discount.
2. Reducing your risk after the market already drops. While some people continue to make contributions to their retirement plans during a crisis, they often make the mistake of reducing the risk while they are making those contributions. I would argue that they should do the exact opposite. You can maintain the investments for the existing balances in your account, but new contributions should probably be made into more aggressive funds to capitalize on the prices that were most affected — the more aggressive funds. Those are the funds that are likely to grow the most over the coming years after the crisis has passed. The tendency to want to “protect what’s left” is exactly what will end up hurting you more in the long run.
3. Forgetting about fees, taxes, expenses and budgets. During a crisis, we tend to focus so much on the crisis itself that we often overlook all the little things that can really add up to big things. For starters, one way to minimize the impact of portfolio declines is to make sure you aren’t making the problem worse by not being as tax efficient as possible with your investments. Adding high taxes to a portfolio that is losing money only compounds the problem. Likewise, paying unnecessarily high fees also adds to the problem. If you are withdrawing funds from your portfolio during a market decline, you are creating negative compound interest. The lower the account value, the larger the percentage that you need to withdraw in order to maintain the same income. This causes you to spend down your principal at an even faster rate. This is a great time to review your budget and see if there is a way to cut out any unnecessary expenses to minimize the amounts you take out when the account value is down. Small reductions in your budget can add up to substantially larger portfolio balances down the line due to minimizing the negative compound interest effect.
Be sure to check out the next issue for the rest of the list.
T. Eric Reich, CIMA, CFP, CLU, ChFC is president and founder of Reich Asset Management and can be reached at 609-486-5073 or email@example.com.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. Neither Kestra IS nor Kestra AS provides legal or tax advice.