Defending Yourself Against a Market Correction

Jane Young, CFP, EA

Jane Young, CFP, EA

The recent increase in the stock market is making a lot of investors nervous about the possibility of a significant correction.  I am frequently asked what the market will do over the next few months.  In reality, no one can predict market performance, especially in the short term. Your best defense against a volatile stock market is to create a financial plan and an asset allocation that is appropriate for your financial situation and time horizon.

If your current asset allocation is in line with your financial goals, there’s probably no need to make major adjustments to your current portfolio.  Your asset allocation defines the percentage of different types of investments such as U.S. stock mutual funds, international funds, bond funds and CDs that are held in your portfolio.  You should establish an asset allocation that corresponds with the timeframe of when your money will be needed.   Investments in the stock market should be limited to money that isn’t needed for at least 5 to 10 years.  Keep money that may be needed for emergencies and short term expenses in safe, fixed income investments like bank accounts, CDs or short term bond funds.

The stock market is inherently volatile and there will be years with negative returns.  However, over long periods of time the market has trended upward with average annual returns on the S&P 500 exceeding 9% (approximately 7% when adjusted for inflation).  It’s important to consider your emotional risk tolerance in establishing your asset allocation.   You may have the time horizon to have a significant portion of your portfolio in stocks but you may not have the emotional tolerance.  Your asset allocation may be too risky if you are tempted to sell whenever the market goes down or you are continually worried about your investments in the stock market.

Establishing an asset allocation that meets your situation can help your ride out fluctuations in the stock market more effectively than trying to anticipate movements in the market.  It’s impossible to time the market and a short term increase is just as likely to occur as a drop in the market.   Although you want to avoid timing the market, you should rebalance your portfolio on an annual basis to maintain your target asset allocation.  Additionally, you will want to adjust your target allocation over time as your financial situation changes and you move through different phases of life.

Keeping other areas of your financial life in order can also help you through a major market adjustment.   It’s essential to maintain an emergency fund of at least 3 to 6 months of expenses,  make a habit of spending less than you earn, and  save at least 10 -15% of your income.

Rather than focusing on where the market is headed and what the financial pundits are predicting, maintain an appropriate asset allocation and keep your financial affairs in order.

Financially Get a Jump Start on 2017

office pictures may 2012 002The beginning of a new year is a good time to evaluate your finances and take steps to improve your financial situation.  Start by reviewing your living expenses and comparing them to your income.  Are you living within your means and spending money in areas that are important to you?  Look for opportunities to prioritize your spending where you will get the most benefit and joy.

This is also a good time to calculate your net worth to see if it has increased over the previous year and evaluate progress toward your goals.  To calculate your net worth, add up the value of all of your assets including real estate, bank accounts, vehicles and investment accounts and subtract all outstanding debts including mortgages, credit card balances, car loans and student loans.

With a better understanding of your net worth and cash flow you are ready to set some financial goals.  Start with the low hanging fruit including paying off outstanding credit card balances and establishing an emergency fund.  Maintain an emergency fund equal to at least three months of expenses.   Once your credit cards are paid off you may want to focus on paying off other high interest debt.

After paying off debt and creating an emergency fund, it’s advisable to get in the habit of saving at least 10% of your income.   Saving 20% may be a better goal if you are running behind on saving for retirement.

Take advantage of opportunities to defer taxes by contributing to your company’s 401k.  If you are self- employed create a retirement plan or contribute to an IRA.  Take advantage of any match that your employer may provide for contributing to your retirement plan.  If you are already making retirement contributions, evaluate your ability to increase your contributions.  If you have recently turned 50 you may want to increase your contribution to take advantage catch-up provisions that raise the contribution limits for individuals over 50.

As the new year begins you also may want to evaluate your career situation.  Saving and investing is just part of the equation, your financial security is largely dependent on career choices.  Look for opportunities to enhance your career that may result in a higher salary or improved job satisfaction.  It may be time to ask for a raise or a promotion or to explore opportunities in a new field.  Consider taking some classes to sharpen your skills for your current job or to prepare you for a new more exciting career.

You may have additional goals such as buying a new home, contributing to your children’s college fund, remodeling your house, or taking a big vacation.  Strategically think about your priorities and what will bring you satisfaction.  Start the year with intention, identify some impactful financial goals and create a plan.  Formulate an action plan with specific steps to help you meet your goals.

Selecting the Right Asset Allocation – Part 2

Jane Young, CFP, EA

Jane Young, CFP, EA

Your asset allocation is the basic structure of your investment portfolio defining the target percentage you want to hold in different categories of assets.   Start creating your asset allocation by deciding how much you want to invest in the two major categories, stock mutual funds and interest earning assets.  Next break your allocation down into more specific categories including cash, CDs, bonds, large cap stock, mid-cap stock, small cap stock, international stock, emerging markets stock and real estate.  Setting an appropriate, well diversified asset allocation helps you balance risk and return within your portfolio.  Your asset allocation may change over time as your financial circumstances change.  However, avoid changing your allocation too frequently based on short term fluctuations in the market.

The appropriate allocation depends on several factors including your age and investment time horizon, your financial goals, other risk factors in your life, your experience with investing and your emotional risk tolerance.  Regardless of your investment goals, you need to maintain an emergency fund of readily available funds equal to at least four months of expenses.

Your financial goals are a major determinant in setting your allocation.  Identify your major financial goals and when money is needed to support these goals.  Design an asset allocation to meet these goals.  Money needed in the short term should be held in safer, interest earning investments. The stock market should only be used for long term needs – generally at least five to seven years out.

You may be able to assume more risk in your portfolio if the timetable for your goals is flexible.  The timeframe for money to cover things like college education or your emergency fund may be firm but there may be some flexibility on when you take a major vacation, remodel your home or plan to retire.   Money needed for retirement is generally spent over twenty or thirty years.  You won’t need your entire nest egg on the first day.

Your allocation is also dependent on risks taken in other areas of your life.  For example, if you work in a volatile career with unpredictable earnings, own a small business or own rental property, you may want to reduce the risk in your investment portfolio. On the other hand, if you have a secure job and anticipate a generous pension, you may be comfortable taking more risk.

Regardless of your situation you need to feel emotionally comfortable with your allocation. If you are constantly worried about market fluctuations you may need a more conservative allocation.   Historically the stock market has trended upward, but there will be years with negative returns.  Create an allocation that gives you adequate emotional security to ride out swings in the stock market and helps you avoid selling when the market is down. If you are new to investing, start out slowly and test the water to see how you will react in a volatile market.

Smart Financial Moves for College Graduates

Jane Young, CFP, EA

Jane Young, CFP, EA

After finishing school and hopefully landing a rewarding job, college graduates face a myriad of financial obligations and opportunities.   Here are some steps for graduates to get started in the right direction.

Create a Budget and Live Below Your Means – Based on your income, create a spending plan that leaves you with a little extra money at the end of the month.  Your budget should include saving at least 10% of your gross income.  Spend less than you earn so you are prepared for unexpected bumps in the road.  Initially this may involve renting a smaller apartment, living with roommates or driving an older car.  As your career progresses, avoid increasing expenses in lock step with earnings increases.

Establish an Emergency Fund – With the money you are saving, build and maintain an emergency fund equivalent to 4 to 6 months of expenses.

Avoid Credit Card and Consumer Debt – Pay your credit card bill in full at the end of every month.  If you can’t afford to pay for your purchases when the bill arrives then postpone or re-evaluate the purchase.   Avoid or minimize debt on vehicles and other consumer purchases.

Payoff Student Loans – Devise a plan to payoff your student loans.  Consider consolidating or refinancing your loans if it will save you money.  Consider both the interest rate and the duration when evaluating loans.  Generally, you want to pay off student loans in less than ten years.

Buy Adequate Insurance – It’s essential to have good health insurance coverage; if you aren’t covered by your employer you may be eligible for continued coverage on your parents plan.  You will also need good car insurance and renters insurance on your apartment.  Additionally, consider long term disability insurance and an umbrella liability policy.

Contribute to Your Employers Retirement Plan – Many employers offer a 401k or 403b plan to help you   save for retirement using before tax dollars.  At the very minimum contribute up to the match that your employer may provide.

Contribute to a Roth IRA – Once you start earning money you can also save for retirement by contributing to a Roth IRA.  The benefit of a Roth is since you initially invest with after tax dollars, you don’t pay taxes when the money is withdrawn in retirement.   This is a tremendous opportunity for recent college graduates because your money can grow tax free for forty or fifty years.

Travel and Have Some Fun – While you’re young and relatively independent, set aside some money to explore the world or do something adventurous.  Once you buy a house, start a family or assume more job responsibilities it’s harder to get away.

Educate Yourself on Finances – Start reading personal finance books and articles.  Here are a few books to consider; “The Money Book for the Young, Fabulous and Broke” by Suze Orman, “Personal Finance for Dummies” by Eric Tyson, and “The Millionaire Next Door “ by Thomas J. Stanley and William Danko.

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