If the debate over the recession and extreme market downturns have you stressed, there are three simple steps you can take today to give you more peace of mind. Two things are going to be financial related. And then one is sort of a hack that I learned recently, and I think it’s actually changing my life for the better. And I thought, how could I hold that back? I’ve got to share that with you as well.
When it comes to a recession or other financial worries that bring anxiety to our minds, there are some immediate actions you can take now.. Picture three buckets – Bucket #1 is made up of asset classes that historically do not get impacted as much by stock market movement. Once you know what you have in bucket number one, you can find out how many years of income you have in “safe” assets. If you had $100,000 total in investable assets and were taking out $5,000 per year, and you wanted to have at least five years worth of withdrawals in safe money, you might have $25,000 or 25% of your investment mix in the conservative investments. That $25,000 would be Bucket #1. During recessions or down periods, we want to avoid selling anything from the growth bucket, or growth investments if we can, so that we can give them a chance to recover.
If you’re working and retirement is five or more years away, then Bucket #1 isn’t as much of a concern because you’re not going to be drawing from your retirement accounts, but it’s still a good idea to have an emergency fund. You should do a ballpark estimate of what your monthly expenses are, and then just make sure that you have enough to weather a storm if you were to lose your job, if your pay changed for some reason, or something unexpected came up. Having the conservative assets or cash on the side allows you to not go into debt if one of those bad scenarios happens.
The next thing is taking advantage of recessions or downturns versus taking a beating by them. The first thing you should do is have a rebalancing system set up. If you’re sticking to a certain asset allocation (ie, 40% of your dollars in conservative assets and 60% in growth assets), then market fluctuations can often put that allocation out of alignment as the value of growth assets fluctuates or drops meaningfully. Having a rebalancing system means you get an alert when you need to rebalance and put things back into alignment if they were ever out of whack. If we leave decisions like when to sell and when to buy up to our emotions, we have a harder time implementing that rebalancing strategy, but systems hold us accountable because they are unemotional.
The next way to think about taking advantage of bad markets is using Roth conversions when things are down. The main reason to do this is that you can essentially pay the same amount of tax that you would have whenever the market was at a previous high, but you get more shares into your Roth IRA versus however many months ago. As values go down, you can take the same dollar amount, what you were going to pay in tax, but get more shares into the Roth. When the market recovers, you’ll have paid the taxes on a smaller overall dollar amount than what the shares are worth, but now they’ve grown in that tax-free environment of the Roth IRA instead of the tax-deferred treatment of a traditional IRA.
Onto this third thing that I recently learned…
This is changing the way I think about bad markets. It’s not exactly financial, but you can apply this thinking process to your approach to financial decisions. When something happens, the first thing we do is decide if this is positive or negative, and whichever one we decide paves the road for how we respond. That energy could either be anticipation – looking towards something that’s positive, or anxiety – wanting to avoid or worry about something in the future. The thoughts we have then determine the actions we take. If you can be conscious about that first decision (whether something is positive or negative), and be aware of how you react, you can make more deliberate decisions about the event. So, seeing a market downturn as an opportunity that could serve you in the long run, as opposed to a disastrous event that will ruin your financial situation today, allows us to respond more calmly and proactively and ultimately make wise decisions that get us out ahead.
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