- Inflation – It is a surprise to very few that the prices of things are going up. The exact percentage or measure is less important than the impact on you. You may not even see the price go up, but may see it gets you less for the same price (shrinkflation). The bottom line is that you need to budget more for the same things. Anyone who says they know when inflation will peak or what it will be in the long run is just guessing at this point.
- Interest rates are going up – In order to help curb inflation, the Fed raises interest rates. History has shown that the Fed is often wrong and often overcorrects. What this means for you is that the cost of mortgages, credit cards, and other lending is going up. It also is common to see a recession as a side effect.
- Recession – A recession, by definition, is a period (usually 2 quarters or more) of economic decline (measured by GDP) connected with other indicators, including the stock market going down, a rise in unemployment, and the like. The definition is less important than the impact on you. The biggest risk from a recession to an individual is the loss of their job.
- Market going down – The past three years have seen incredible growth in the stock market. It is unsurprising to see that 2022 has started as a down market and is nearing ‘bear’ territory. A bear market is usually defined as when the market is down 20%. For you, this may mean that looking at your 401k is a bit scary right now, but ups and downs are common in the stock market.
- Political Instability and War – Everyone seems to see political instability from their own lens. Each administration is seen by some people to be the worst ever. Financially, it is not so clear. At the same time, any war is scary. While we all may have strong personal beliefs about politics, financially, politics tends to have very little long-term impact.
The bottom line is that much of what we see in 2022 is not abnormal. What is different now is that we are bombarded by information 24 x 7. While I love being informed, I find that taking a bit of detox from social media and news often helps me to recenter and worry a bit less.
2. Go back to the basics – get on a budget
If you think tough times are here (or coming), then it is time to go back to the basics and get on a budget (or tweak your current budget). Budgeting isn’t sexy, but it is doubly important in times of inflation. If you continue buying the same amount of stuff as you did last year then you will have to have more money (a lot more in some cases) to maintain the same level. Having a good budget that you follow will also protect you from any debt you may have and if you lose your job due to a recession.
Budgets are like diets. There are a lot of them out there, and they all work. Just like a diet, what is most important is the one that works for you. With my clients I often use my Money Management System, which breaks your budget into Musts, Shoulds, Coulds, and Won’ts:
- Musts – Everything you are required to pay to keep a roof over your head and basic food. Musts include rent (or mortgage), utilities, basic transportation, groceries and any minimum payments you are required to make. Knowing your Must number is important as it is your bare bones budget that must be covered if times are rough.
- Shoulds – Include things that need to be covered now but could be cut out if times are tough. For example, cable TV is not a must. If you have debt, paying off your debt is a should (as is saving for retirement and investing).
- Coulds – Reflect your discretionary spending. Eating out is a Could, while groceries are a Must. Vacations, spending money, and shopping go here.
- Won’ts – We all have a list of things we shouldn’t be spending money on (mine is Amazon) which gets added here. You know your own guilty pleasure or poison (depending on your perspective).
With a budget in hand, you know what you Must cover each month if times are tight, and what needs to be cut back now in order to save for rainy days.
3. Pay off your debt.
Debt is stealing from your future and is getting more expensive. Any variable interest debt (i.e. credit cards) has already gone up and will continue to go up. A rise in interest rates both makes the debt more expensive and may increase your monthly minimum payment. In some cases, your monthly minimum payment may not even cover the interest. The key is to get out of debt now before things get worse. If you are deep in debt and then lose your job (or other issues hit) then you will go from barely keeping your head above water to sinking.
Start by locking all of your credit cards and eliminating debt as an option. It is nearly impossible to get out of debt if you are still taking out more. Locking your credit cards (so you can’t use them) will help to keep you on budget. Don’t worry about the points or cash back as those are not going to make you rich. You need to realize it is possible to live a life without debt.
With your cards locked, the next step is to set a measurable goal. If you try to get out of debt by paying it off with “what is left over at the end of the month,” you will not make progress. Set a goal, such as to pay off $6k in debt in a year, and then you can work backward to budget $500 per month towards debt.
I recommend the “Snowball Method” for paying off debt. In the snowball method, you pay your minimum payments on everything and then put all extra money towards the smallest debt first. Once you pay off the smallest debt, you then can take everything you were putting into it and put it towards your next smallest debt (therefore building the snowball). Celebrate each debt you pay off and use it to push you towards making more progress.
The other option is the “Avalanche Method” which pays off the highest interest debt first. While mathematically, the avalanche method might be better, it takes a lot longer to get wins, which can discourage some people. In the end, it really doesn’t matter which method you use as long as you are making progress.
4. Assess your risk level
With a solid foundation of information, a budget, and your debt under control, it is time to assess your overall risk level. If your finances, debt, or investments are keeping you up at night, you may have taken on too much risk. Your body may be telling you that something is wrong before you even know it. Here is a quick risk assessment that includes questions to ask yourself:
- Budget – Am I living paycheck to paycheck? Am I making enough money to cover my expenses? If not, what has to be cut to make it work (or how can I make more?)
- Debt – Is my debt holding me back? Am I stuck in a debt cycle (i.e. using debt to make it paycheck to paycheck)? Can I sell something to get rid of debt (i.e. a car, RV, or the like)?
- Insurance – Do I have appropriate levels of insurance on my home and car? Do I have the right healthcare insurance? Do I have disability insurance? Do I have a plan for long-term care?
- Investments – Do I have a diversified portfolio of investments? Have I taken on leverage for my investments that I cannot maintain? Does my mix of investments match my own personal risk tolerance?
- Career – Is my job at risk or in danger? Do I need to reskill now for an uncertain future?
- Emergency Funds – Do I have 3-6 months of emergency funds? Are those emergency funds in something relatively safe such as a High Yield Savings Account?
Risk comes in a variety of forms. Focus on what you can control and cut back your risks now before times become more turbulent. You need a solid foundation set now before you can move forward.
5. Follow your plan.
Your financial plan should take into account the ups and downs of the market and the world at large. A comprehensive financial plan will include your budget, debt, career, investing, and more to provide a reasonable return for your acceptable risk level. Your plan should not be created only for safe times but for your entire life (and may adjust over time). When times get tough you should be able to review your plan and see if any core beliefs are off. If nothing has changed your core beliefs then you can safely stick to your plan, even in turbulent times.
Your plan should include these areas (among others):
If you don’t have a comprehensive financial plan set, it is time to start planning. You can start with books like J.L. Collins’s The Simple Path to Wealth, or you can get someone to help you. While there is much you can do on your own, having someone to look over your shoulder or bounce things off of may help to bring down your anxiety level, especially in tough times.
If you do want someone to help you, look for an Advice-Only, Fee-Only, Fiduciary, CERTIFIED FINANCIAL PLANNER™. Advice-Only means you pay them for their time on a retainer or hourly basis (not a percentage of your assets) and they help you to manage your own finances. Fee-Only means they are only paid by you (they don’t get commissions or other kick backs to sell you products). Fiduciary has a lot of components, but the bottom line is they have to put your interest ahead of their own. Someone who is a CFP® professional has the leading certificate in personal financial planning and has demonstrated they have the education, experience and ethics to help you.
You can look for a CFP® professional at https://xyplanningnetwork.com, https://napfa.org or https://feeonlynetwork.com I am also an Advice-Only, Fee-Only, Fiduciary, CFP® professional and would be happy to help you. You can schedule a no-cost, 60 minute introductory meeting with us at https://calendly.com/coachdrjay/childfree and you can learn more about us at https://childfreewealth.com