The Current State of the Economy and How to Protect Your Finances

During two recent free Savvy Ladies sessions, volunteers Richard Ibarra, CFP,APMA, CRPC and Keri Lai financial advisor, both from Ameriprise Financial Services LLC, as well as Amy Irvine from The Rooted Planning Group and Michelle McKinnon, Wealth Advisor at Klingman and Associates, LLC, went over the current state of the economy, helping our audience understand what’s behind the ongoing inflation, interest rates increases, and how to protect personal finances from all the uncertainty and volatility. Read the main takeaways below.

Understanding Inflation and Interest Rates

The ideal yearly inflation rate (how much prices rise) in a healthy economy ranges from 2% to 2.5%. During 2022, inflation has been around 8% in the US. The last time the country had such a high inflation rate was in 1982-83. How did we get to this point? In short, very low interest rates encouraged the purchase of goods and properties during the past couple of years, especially during 2021 when the economy reopened after the 2020 lockdowns. A 0% interest rate made it very easy to buy houses, cars, and other goods. This increase in demand that boomed last year, created an increase in prices. The bottleneck in supplies caused by the pandemic and, more recently, the war in Ukraine, also contributes to inflation due to a lower supply of goods.

Why are interest rates being increased? Generally, the Federal Reserve increases interest rates to stimulate or slow down the economy. Increasing interest rates means the Fed is pumping up the breaks on the economy in order to stop inflation. Higher interest rates will start to slow down house-buying, car-buying as consumers start to cut down on that consumption. Inflation itself also slows down consumption: once prices become so high, people spend less.

It may take some time to see the effect of the interest rates increase. Adjusting interest rates to manage inflation is a delicate balance. If interest rates rise too quickly it could slow down the economic recovery, affecting businesses and employment. 

Not all economy related news are bad, though. The employment statistics remain promising: 1.5 million new jobs were created over the last three months, which is very positive. 

Ways to protect yourself and your finances

During times of increased market ups and downs, it’s important to remember these three steps:

1. Don’t panic, keep your emotions in check

    • Be disciplined. As Richard Ibarra says, “making money feels good but the fear of losing money overweighs it”. News headlines about the stock market, the war in Ukraine, and the raise of interest rates by the Fed may cause you to panic and want to sell out your investments. “But making changes during times like this is actually when you lock in a lot of losses and you reduce your upside potential”, Keri Lai says. If you sell all your investments during a market drop, you will miss out on the potential gains during the recovery. Meaning you’ll sell at a low and buy back at a high. So don’t let your emotions decide your course of action and be disciplined. If you have a solid financial plan, down markets should already be accounted for. 
    • Stay invested, and only take out money needed for the short term. That’s what an emergency fund is for–roughly 6 to 12 months of expenses that will allow you to weather tough times. 

2. Be diversified

    • In a volatile and uncertain environment, being diversified is key. Have different types of investments in your portfolio to make sure it’s appropriately diversified. 
    • Determine your risk tolerance and find the right investment mix to align with it. Make sure to hold stocks from different sectors and industries, the right balance of equities and bonds. 
    • Don’t be tempted to abandon diversification in uncertain environments. For example, if you’re tempted to move your investments to a “safe asset” like cash due to market volatility, in an inflation environment, cash is not a good option since its purchasing power is constantly declining.  

3. Review goals and expectations

    • Review your financial plan with your advisor if you have one, and determine if you’re still comfortable with it, if you’re still on course to meet your goals. Do you want to quit your job? Are you looking to retire and move to a new city? Check in with your goals and reset your expectations of how to get there. 
    • Rebalance and readjust your account to make sure you’re taking an appropriate amount of risk. Keri recommends a moderate-allocation portfolio, with about 65% invested in stocks and 35% in bonds. For example, if during the last two years, the equity side of your portfolio went up in value, you may see that now it’s 80% in stocks. That means you might be taking more risk than you intended to. You can rebalance your portfolio by selling your gains and buy back at the lows, readjusting your portfolio so you’re taking an appropriate amount of risk. Many 401Ks even have a “rebalance” button and you can set up an automatic rebalance quarterly or annually.
    • Once you’re done with rebalancing, just stick to the plan. If you have a good, diversified financial plan in place, these short-term volatilities shouldn’t affect the long-term output.

Lastly, the experts also recommend to take this moment as a reminder to have all your affairs in order when it comes to protecting yourself and loved ones from the impact of unexpected events. Look into life, disability and long-term care insurance (for the latter, it’s recommended to start between ages 55-70). Make sure beneficiary designations, power of attorney, will and testament, and healthcare directives are all updated. As challenging and uncomfortable it might be to address these topics, failing to do so will create a far more painful and difficult situation should the unexpected happen. 

The bottomline

During uncertain times, you can protect your finances through your investments. People tend to step away from equity into bonds when in fear of the stock market crashing. But you should not change your investment strategy based on the fear of uncertainty. It’s unsettling to see your accounts go down, but when the markets are down is not the time to pull out, it’s the time to stay invested and even add money to your portfolio, 401k, etc. During a market downcycle, don’t change your investment strategy.

Do you have any financial questions? Contact the Savvy Ladies Free Financial Helpline today and get free mentoring from a financial advisor.

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