Originally published 11/9/09 at FPA's All Things Financial Planning Blog
Robert Schmansky, CFP(r)
Don’t allow short-term emotions to sidetrack what you learned from the panic of 2008.
Over the last several months, we’ve gone from the greatest economic downturn since the Great Depression, to a tentative declaration by pundits, including Federal Reserve Chairman Ben Bernanke, that the recession is likely behind us.
You fought your personal financial battles during the crisis — whether they involved changing spending and savings patterns, or reconsidering the appropriateness of your investment portfolio’s asset allocation.
The economy does appear to be recovering — or at least stabilizing — and you might be starting to feel comfortable about your finances and your plan. But just as you shouldn’t allow emotions to rule your financial decisions when times are scary, don’t let a new sense of relative calm undermine the progress you have made. If the recent economic crisis has any parallels to the 1930s — and I believe it does — there may be additional setbacks on the road to recovery where personal thrift and a conservative plan will be critical to your ultimate success.
Internalizing the practices you adopted, as well as relearning a few important rules of thumb, can help you maintain your progress and lock in the lessons you’ve learned.
As you move forward, keep the following key principles in mind:
Cash is king. (And queen, prince and duke.) Your home equity line of credit is no substitute for cash reserves. Keep at least 30 percent of your income in emergency cash, and twice that amount if you are self-employed, and more still if you are retired or temporarily unemployed.
Save for a rainy day & plug the leaks. Budgeting is one way to get a hold of where your cash disappears to every month. Online tools such as mint.com can help. Since the goal of a budget is to live within your means and make sure you are saving for future goals, another way for the ‘budgeting adverse’ to tackle this task is to follow Stephen Covey’s advice and start with the end in mind; save 15 to 20 percent of your income and make the rest of your budget work without taking on debt.
Focus on asset allocation. A helpful asset allocation/diversification rule of thumb is to invest 100 less your age as a percentage of your portfolio in stocks. Thus, for example, if you are 55, 100 – 55 = 45 — i.e. suggested 45 percent stock allocation in your portfolio. However, a more customized target stock allocation will vary greatly based on your personal risk tolerance and goals. Parts of your portfolio should be invested in low- or no-risk assets, and your portfolio should be sufficiently diversified so that some assets will be going up in value when others go down. We’ll cover this topic in future FPA blog posts, however, for now know investing in high risk bonds and stocks that move together is not diversification.
Don’t keep all your eggs in one basket. Your primary source of income is probably your salary from your employer. Therefore, unless you are a small business owner, for diversification purposes, you should limit your holdings of employer stock and bonds to 10 percent of your investment portfolio.
Your home is for living in, not flipping. Its value should be 2-2.5x your income. Slightly more in some areas, but having a “right-sized” home is a crucial part of your financial picture. And remember, you will always need to live somewhere, so your primary residence should not be seen as the same kind of “investment” as something else that you can sell without replacing.
Acting upon these basic rules of thumb should help keep you on a solid financial footing, whether we have indeed turned the corner on the economy, or have more big bumps in the road ahead.