At the end of each year, it is good to review your finances to see if there are any lessons you can learn moving forward.
Given that 2020 was so chaotic, a financial review this year is especially important.
The main financial lessons from 2020 aren’t especially surprising, however. In fact, if 2020 taught us anything, it was the importance of good personal finance habits. Let’s examine three things 2020 taught us about money management.
n Have an emergency fund
Having an emergency fund that could cover between three and six months of expenses is sound advice at any time.
This year, the value of the emergency fund became more obvious.
Millions of Americans found themselves unemployed in one of the most dramatic unemployment spikes in the nation’s history.
For those without an emergency fund, the lack of savings added additional stress to an already stressful situation.
For those with an emergency fund – unemployment was certainly not fun, but it was far more manageable and less stressful.
n Have the right mix of stocks, bonds, and other assets in your portfolio
Whether you invest in a work-sponsored retirement account or on your own, you have the opportunity to choose what percentage of your retirement assets are in stocks, bonds, a money market, or in other assets. Having the right mix is important – and experts generally suggest the mix should vary by age. If you are closer to retirement, you’ll want less in risky assets like stocks and more in safer assets like bonds. If farther from retirement, you can handle short term swings more easily, and can have more in high risk assets.
In 2020, in a little more than a month, stocks lost about one third of their value. For those far from retirement (like me), this volatility wasn’t too concerning, as there is a long time before retirement. But for those who are close to retirement, a 1/3 downswing in value can be terrifying. This can have a huge impact on a person’s retirement standard of living.
This downswing reinforces the sound advice to move more of your portfolio into less risky assets as you get closer to retirement. Asset allocation matters, and this should be determined before a downswing happen, with the understanding that downswings can and will occur.
n Choose your stock/bond allocation, then don’t think about it
As mentioned above, stocks lost one-third of their value in the early part of 2020. And there seemed to be a good reason for these losses. COVID-19 was one of the most disruptive events of our lifetimes. But as I write this, the stock market has since recovered and reached a record high. Those who panicked and took money out of the stock market lost out on significant value.
As a general rule, once you have made your choice of stocks and bonds – hopefully in mutual funds or an index fund that simply tracks the stock market – it is best to not think about your portfolio balance too often. Just let your money work for you. And you definitely should not try to time the market – amateur investors are terrible at that. For amateur investors, and even for most professional investors, the best thing you can do is to allocate your funds appropriately and then don’t pay attention to short term swings.
A new year is a good time to reflect on decisions. In 2020, financial markets and unemployment rates were volatile, which reinforced sound and simple financial advice. Hopefully 2021 isn’t as crazy as 2020, but regardless of the way 2021 unfolds, this advice should serve you well.
Matt Rousu is dean of the Sigmund Weis School of Business at Susquehanna University and author of the book Broadway and Economics: Economic Lessons from Show Tunes.