Despite the spate of predictions at the start of the year, very few forecasters can claim long-term success at looking into the future. Events and context change, demanding changes in investment strategy. But basic principles stay the same.
You need to hold firm to your basic standards, which must be set based on knowledge. In a calm moment, you need to figure out your “risk tolerance” — an economic term that stands for: “How much money can I afford to lose?” Then you must have the knowledge to truly evaluate the risks you are taking when you make money decisions. If you decide you can’t lose even one penny, you’ll probably want to leave your money in insured, short-term deposits, despite the fact that you earn almost no interest these days. But if the greater long-term risk is “running out of money,” then you’ll want some exposure to the stock market, which has always provided more growth than chicken money over the long run (20 years), even adjusted for inflation.
Even if you have this basic knowledge, you have to make adjustments in your strategy as events change. This is the time of year to make those adjustments.
One thing is sure: If you want the year to end with an improvement in your personal finances, you’ll have to be flexible and willing to change, and be open to new ideas.
The first step is to get some perspective about what’s going on in the economy. This year will be the most “political” year, not only because it is an election year, but also because there are so many huge economic issues confronting us. Within the next few months, Congress will have to vote on raising the debt ceiling, extending the payroll tax cuts and increasing funding for the U.S. Postal System. Then, by year-end, they will be faced with the expiration of the extended “Bush tax cuts.” And in between, it’s likely that the Supreme Court will force a rethinking of President Obama’s health care plan, which will need funding if the mandate to purchase health care insurance is declared unconstitutional. Energy is becoming a political issue, as well, with the president’s decision to rule out the pipeline from Canada that could bring us cheaper oil.
Every financial decision facing Congress will carry a political price in this election year. So the best bet is another year of political wrangling and divisiveness. And that wrangling will impact the interest rate and stock markets, likely making them more volatile and creating more headline days. It’s that kind of volatility that you must steel yourself against. Think of how many headlines there were about big moves in the market last year. Then put those scary days into perspective. According to Dow Jones Indexes, the Dow Jones Industrial Average ended the year with a gain of 640 points. But in between it traversed 28,032 points, if you add up all the closing gains and losses.
Surely there were a lot of emotional trades made on both sides during those headline days. Into this mixture, you’ll have to add two huge global considerations that will weigh on your personal financial decisions. Most immediate is the concern of Europe’s banks and their ability to finance all the European country debt they hold. With country credit ratings being downgraded, there will be fewer institutions able to buy the already outstanding debt, not to mention the billions that must be refinanced as they come due this year.
The second great global concern is Chinese growth. A few years ago, there was a lot of China-bashing, condemning the growth of China at the expense of jobs here. Now, the world is worried about a Chinese economic slowdown that would impact our exports of grain and farm machinery, as well as world trade. European countries need China to buy their products to keep Europe out of recession. As Walt Disney said so well: “It’s a small world, after all!” That small world is impacting our jobs, our prosperity and our future, as well as your investments.
Based on history, there’s no reason to believe our nation, and our personal finances, won’t come out ahead again if we go with the flow of change, instead of standing against the tide. Let’s start with a belief that the world is not coming to an end, whether over the euro, or our national debt, or the Mayan calendar predictions. Given that premise, our immediate need is to survive this year in a way that prepares us for the future.
Take a quick look back. If you’ve survived so far, you’ve come a long way. Based on historic cycles, we should be more than halfway through our problems. This is not the time to give up planning. Whether you’re debating about the stock market, concerned about risk to your savings or simply wondering how to keep a roof over your head — or find a new one if you’ve lost yours — you’ve made it through the worst of the crunch.