Financial Planning Lessons from the 21st Century so Far
The 21st century has been quite an interesting time for people from all walks of life. Whether it is politics, entertainment, business, or finance, the world has seen many surprises, advancements as well as downfalls. The finance industry, in particular, has seen several economic downturns and crashes and has also successfully recovered from them. The 2001-2002 Argentine Economic Crisis, the historical 2008 Global Financial Crisis, the 2014 Russian Financial Crisis, dollar to peso fall, housing bubble burst, and Saudi Arabia emerging as the new oil leader, the 21st century has been bestowing people with financial lessons as well as warnings. The era has a lot to narrate and teach investors about handling money, investments, and finances.
Here are the top 7 financial planning lessons to learn from the 21st Century so far:
1. Assess and evaluate risk
The risk in financial planning and investing is at two levels. The first is at the investor level and the second is at the instrument level. Before investing, you must understand your risk level and type. On a broader level, investors are of two types, passive investors and aggressive investors. Passive or conservative investors are those who have a low-risk tolerance and prefer investing in safe and assured instruments. Aggressive investors, on the other hand, are those who have a high-risk tolerance and make investments in instruments that may pose more risk along with high returns.
The second level of risk lies at the investment instrument level. It is crucial to understand and realize that various investments carry high risk, such as stocks and equities. Although the reward is also quite high, the risk cannot be neglected.
2. Have an emergency fund ready during all times
An emergency fund is a rainy-day fund that must be easily accessible to you in the hour of need. As a general rule, an emergency fund should be the equivalent of your three to six months’ salary, but it may vary depending upon the size of your family. Some experts suggest keeping an emergency fund that is equal to your three to six months’ salary plus the cost of your last emergency. An emergency can be anything from a medical situation to a sudden loss of a job. The important thing to note here is that you must be prepared to deal with any possible adversary.
3. Plan and save for your retirement
Retirement is an inevitable event. Sooner or later, you will retire from your busy work routine and professional life. So, you should spend a good amount of time on planning to save up adequately for your retirement. The better planned and funded your post-retirement life is, the more relaxed you and your family will be. It is important to evaluate all the available options, including a 401(k) account, Roth IRA or Simple IRA, mutual fund investments, employer-based retirement plans, etc. Social security is another important factor to consider while planning for retirement.
4. Don’t just look at the past, evaluate the present and future as well
In financial planning and investing, investors often look back at past trends to make decisions that will affect the future. This may not always be the right approach. Past trends are reflective of how the underlying instrument or company behaved under certain conditions, but they are not a fool-proof guide to future performance. In addition to this, when you evaluate past trends, looking at just the recent past may lead to false conclusions, as a hike or downfall might be a result of certain economic or political conditions. To have a better understanding of the instrument’s performance, you must understand the pros and cons of your investment in its entirety. This includes analysing the risks involved, probable returns, future goals, etc.
5. Follow a balanced approach to your investments
Investing is crucial, and so is investing optimally. Whether you are a conservative investor or an aggressive investor, it is important to strike the right balance of risk and reward in your investment portfolio. Even though a conservative investor invests in low-risk tools, avoiding risk in totality can lead to minimal earnings, ultimately affecting your wealth preservation. On the other hand, aggressive investors must not overexpose their investment portfolio to excessive high-risk tools that could lead to instability in the portfolio.
Striking the right balance is crucial to ensure both capital preservation and appreciation over the investment horizon. Your investment portfolio must contain bonds or other equivalents that bring stability to it. Likewise, some profit-earning instruments like stocks or mutual funds are also important to ensure growth.
6. Diversify your investment portfolio
Financial planning and investing are very dynamic domains. You need to stay alert at all times to encash every passing opportunity. A common approach followed by many investors to protect their portfolio from market fluctuations is by diversifying. Diversification is a hedging solution that allows investors to diversify across different domains and industries to ensure that the risk is minimized and the profits are maximized without a regular need to time the markets.
Diversification is essentially spreading your investments in unrelated industries so that they do not bring down each other during a bearish phase. When you are invested across different industries, your whole portfolio does not get adversely affected by investing in certain industries and, hence, averages out the loss in the long run.
For example, if you maintain an investment portfolio spread across sectors like automobiles, oil, rubber, and steel, a sudden fall in the sale of automobiles can lead to a fall in the share price of the automobile industry. This can show a negative return across all your investments. This is primarily because your investments are diversified across related industries. A fall in automobile sales would ultimately lead to a fall in demand for raw materials and their respective share prices. If, on the other hand, you invest in sectors like automobile, food and beverages, clothing, or consumer durables, only the automobile shares are coloured in red while the rest remain unaffected under this situation.
7. Save more than you spend
Most people grow up listening to this advice, but only a few incorporate it. Spending is easy and instantly rewarding, whereas saving is hard without any instant rewards. Of all the financial crises that shook the 21st century and the ones that occurred before, the one thing in common that affected people was the dearth of savings.
Saving money is not an act of choice but the need of the hour. If you cannot resist the urge to spend, automate your savings before you get the money credited to your account. A simple 50-30-20 rule can be easy to follow. As per the rule, you can allocate 50% of your earnings to needs, 30% to wants, and the remaining 20% to savings. Saving regularly is extremely helpful in battling rising inflation and achieving your long-term goals.
To sum it up
Financial planning is vital to living a balanced life. Since matters of money can at times leave you with no space for a plan B, having a viable financial plan in place right from the start can ensure financial health and stability in all stages of life.
Do you think your financial plan is comprehensive and fool-proof to meet the changing demands of tomorrow? Get in touch with financial advisors to be sure.