Friday, August 28, 2009

Don't Be Reactive

Money Saving Tip #180 - Don’t Be Reactive. All I hear about nowadays is the economy and how bad it is. And conversations abound in real life and on Internet forums about what everyone is doing in response to the economy. Are we eating out less? Have we stopped putting money in the stock market? Are we increasing our emergency savings?

All of these are conversations are reactions to the “depressed” economy. And while I think the poor job market and the high rate of foreclosures has served as a wake-up call to much of the US population, people shouldn’t be making long-term financial decisions based on the current poor economy. Instead they should be making financial decisions in spite of the poor economy. Otherwise they are just reacting to what is happening today. What the financial world will look like in 1 year, 5 years, or 10 years is anybody’s guess. So we need to make our financial plans for all types of markets. Following solid fundamentals will get us through bad times and good ones. The stock market will go up again. And it will go down again. The unemployment rate will be lower than it is today. And one day it may be higher. Mortgage rates may reach double digits one day or maybe they will be steady for several years. Inflation will go up. These things will happen. We will not always be in a recession, although it seems like it right now.

So rather than react to market conditions today, why not plan your finances around any type of market scenario. Have a solid emergency fund for realistic emergencies. One need not go overboard in saving for emergencies unless you really feel like there is a good chance you will lose your job or have something similarly disastrous happen. Financial experts have always recommended 3-6 months’ emergency fund. Now in the recession many recommend a one-year emergency fund. But a one-year emergency fund may be too conservative, especially if by the time you save for it the recession is over.

Pulling all of your money out the stock market because it has gone down a lot is just a reaction to the poor financial markets. However, if you stuck with solid fundamentals going in, there should have been no reason to panic. The market will go up again. And pulling stocks out when they fall is the worst time to pull it out. In the same vein, investing in the stock market when it has gone up a lot is just reacting to what has already taken place. Instead, figure out what percentage you are comfortable with in the stock market and invest that percentage in it. No need to react each time the market takes a hit or goes sky-high.

The same goes for the real estate markets. Everyone was buying real estate when it was going up, up, up and we all know what happened. Many people got burned. Now many people are scared to invest or buy real estate because it has fallen so much. But real estate can be an important part of some people’s investment portfolio. And even if it’s not part of yours, you still will want a place to live. Buy a house that you like in a neighborhood that you love, and don’t worry about the real estate market. Over the long-term, chances are that housing will go up. Don’t just make decisions on what has happened in the past few months or couple of years. That is very short-sighted.

While I think this recession, has made many people aware of their lack of financial planning. I think many are not going to plan for the long-term, instead make decisions on what is happening today. And then when things happen tomorrow, they will reaction to those conditions. While we can’t predict what will happen in the short or long-term, one thing is certain, financial markets rise and fall all of the time. Our economy won’t always be like this, so don’t base all of your financial decisions like it will be.

In Real Life (IRL) – I am a pretty conservative investor as far as investors go. I have a smaller percentage in the stock market than most other people who invest in the market. But, I am comfortable with the percentage that I have in there. I can sleep at night knowing that I have 20% (or 30% or 40%, whatever the case may be) of my assets in the market. When the markets dropped tremendously last year, I didn’t do much of anything. Oh, I may have checked a few balances once or twice, but that’s it. I did not move one dime out of the market. I know one person, who I’ll call my dad for this story, who got scared by the big declines in the market and started moving stuff out as they were falling. He was being reactive, probably because he had a higher percentage in the market than he should have had or was comfortable with. Seeing that markets are starting to go up again, it was probably the wrong thing for him to do.

In the same regard, we have bought two pieces of real estate in the past 10 years. One was in 2000 just as the market was going up. It was time for us to own a home because renting wasn't conducive to our lifestyle while owning a large dog and wanting to grow our family. As luck would have it, it was the right time to buy. While real estate has come down from its high two years ago, it is nowhere near the lows when we bought it, at least in this area. On the other hand, when we wanted to invest in a condo in Florida with my mother-in-law in 2004, we bought as prices were already starting to climb. While we didn’t buy at the peak, prices have come down to below what we paid for it. Was it still a good investment? Maybe. Maybe not. We bought for the long-term, until our retirement. And in the meantime, it has provided a vacation spot for my mother-in-law each winter. And even if it didn’t, I wouldn’t sell now when prices are low, and inventory is high. Again, that would be reactive.

No one can predict when things will go up, go down, or stay the same. But if you base your investments on a long-term view knowing that things in all areas of your investments will change, probably more than once, while you own them, you will do okay. So plan your finances knowing that things will change from what they are now. Set it up so they make sense in the good times and in the bad, in periods of inflation and deflation, and in up markets and down. For other financially-inspired ideas, check out Life as Mom.

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