Last Updated: August 4, 2009
Unemployment, interest rates, the price of oil, and gross domestic product (GDP). It's hard to read stories about economic trends these days and not wonder how such things affect your investments and financial plan. And you would be right do so, according to financial planners and economists.
Especially now, said FPA member, Marci Rossell, the former chief economist for CNBC. The current state of the economy is different from what the average American has ever experienced. "Where in the midst of a crisis," Rossell said. And that affects every aspect of your financial plan, including your investments.
According to Rossell, the global economy is in the midst of establishing a new equilibrium, a new normal so to speak. "The last decade was not normal," she said. Now, it's unclear when the economy might establish its new equilibrium. In her opinion, inflation at 3 percent, real interest rates at 3 percent; GDP at 3 percent and unemployment at 5.5 percent would indicate that the economy has stabilized.
But it's unclear whether and when the economy will stabilize. What's more, you shouldn't wait until the economy reaches its new equilibrium before you tweak your financial plan and investments.
"There's never been a greater need to plan for the certainty of uncertainty," said FPA board member, Karin Maloney Stifler, CFP®, of True Wealth Advisors, LLC. In this current economic climate, she said you'd be wise to do the following:
- Shore up safety nets, such as cash reserves and insurance before saving for other long term goals.
- Strengthen your personal balance sheet. Work to aggressively repay outstanding consumer debt such as credit cards. And, consider refinancing mortgage debt if there's equity in the house and your current rate is either variable or fixed at a rate of 6 percent.
- Live below your means. Know how much is needed to keep the household running and the spending areas that could be cut if needed. Pay for lifestyle needs with cash not credit.
- Treat this downturn as a teachable moment for everyone in the family. Discuss smart solutions to money decisions with the kids. Show the kids how they can contribute to the family's financial well-being.
- If retired, evaluate whether the market downturn has jeopardized long-term financial security. If so, consider spending less and adding part-time income. Reevaluate investment strategy too.
- Journal your response to the market meltdown and reference your thoughts when future investment decisions must be made. Our true capacity for investment risk has been revealed. We have a tendency to forget pain over time. Carry the lessons forward so that when the market rebounds you don't let greed replace fear and take on more risk than you can really handle.
As for your investments, Rossell predicts that inflation may rise in the not-too-distant future. And that investing in cash equivalents and short-term fixed-income investments might be the best tactical move. In addition, she suggests that Treasury Inflation Protected Securities (TIPS) have a role in every investor's portfolio. And in published reports, she has expressed concerns over long-term Treasury bonds, which she described as overvalued. With respect to so-called risky assets, she says it's hard to determine whether stocks are fairly valued. "It's hard to get a sense of what normal returns will be for
the next decade," she said.
What's easy to get a sense of, however, is this: "One, your home is a place to live," she said. It's not an investment. And if you view it that way, consider it a poorly diversified investment. "We made the mistake of thinking your house and 401(k) plan were substitutable. Remember, volatility and illiquidity are things you don't want in your portfolio." And two, recessions are a good time to invest in your human capital. "This is a great time to invest in yourself, especially if you are out of work," she said. "When earnings are not there, the opportunity cost is low."
And once the economy turns around, Maloney Stifler suggests that you maintain the same disciplines that pulled you through the recession so that you can get back on track to achieving your life goals.
If you need help creating or adjusting your financial plan in light of current economic conditions, consider hiring a financial planner. Find a financial planner.