Our emergency fund acts as a defence between our emotions and our actions. Photo / Supplied
With the corrections occurring in the market and the markets doing what they have always done efficiently … It's time to stop, breathe deep with both feet firmly on the ground, and reassure ourselves of the why and what is of our financial position and plan.
Having a firm base is about checking the basics.
How is our emergency fund? Indeed, do we have one?
This can be one of the most reassuring things in your arsenal. While some may believe the idea of an emergency fund is old-fashioned, the reality is that amid market corrections we will certainly feel more comfortable being prepared with a plan and an emergency fund.
Fundamental financial planning advice prescribes that we should all keep an emergency fund – that is, liquid cash reserves or facilities – that cover 3-6 months of living expenses, depending on our specific situations. While this is not necessarily the maximising return action, it serves other critical purposes.
An emergency fund:
1. Allows us to leave our investments alone when they decline in value. Selling our stocks at their lows to fund short term needs is a recipe for hindering our investment's long-term growth. Doing that is a desperate action.
2. Prevents us from being as susceptible to investing on emotion. If we are following the news when the market crashes, we will see nothing but panic sellers and flashing red numbers - enough to make anybody feel like they should act.
Our emergency fund acts as a defence between our emotions and our actions and will make us feel much better about sticking to our long-term plan when equities decline, which they will in the long-term scheme of things from time to time just as they will go up.
Bonds remain important
When we look at lower earnings as a reason to stay away from bonds entirely, it is important to remember that bonds are part of our investment plan to reduce our portfolio's volatility – shock absorbers if you will – not necessarily to maximise investment returns.
When we look at the volatile tracking of a 100 per cent equities portfolio, as it moves through its more volatile paths it can cause us to constantly question our decisions, not sleep as well at night, or tempt us into needless trading.
Whereas a more balanced portfolio with a useful bond allocation, conversely, has the capacity to earn a strong return without nearly as much embedded risk and volatility. Consider what return you need – and if you can reach that goal with less stress, as with a balanced portfolio.
A bond allocation typically of 10-20 per cent in a growth portfolio, 40-50 per cent in a balanced portfolio, 60-70 per cent conservative, or 80-90 per cent defensive portfolio is sound prudent investing … especially when coupled with sound financial advice and risk profiling, to tailor a portfolio to your individual needs.
We don't know what future equity returns will be. They will not always be as good as we expect. But we at least can have a plan and maintain a suitable portion of our investment portfolio working to mitigate volatility that would otherwise keep us up at night.
The equity markets are a risky place
The higher the risk, the higher the potential reward. Conversely, the lower the risk, the lower the potential reward. The equity markets are a risky place, and they favour those who invest for the long term.
Short-term speculators are notoriously bad at beating the market over the long haul. Past returns are not predictors of future performance. So our funds needed for use in the 3-5 years ideally should not be all tied up in the equities markets.
A caution, we can be biased. When equity markets are up 20 per cent or 30 per cent in a year (sound familiar 2021), investors tend to be biased and think the short-term future will be like the short-term past, and the equity markets can be relied upon for increased returns every year. Reality does not match this outlook.
Market corrections are valuable times for us to re-examine our own plans and asset allocations based on our needs, capacities, and our risk tolerance. If we are taking more risk than we would like and our portfolio dropped more than we could bear, such as this last January, take this as a sign to recalibrate by talking with a professional financial adviser, resetting, and moving forward with confidence with our now fitting reaffirmed plan. Again, sleeping soundly at night.
A time to revisit risk
When the equity markets decline, it's an excellent opportunity to truly gauge how we feel. Be honest to yourself – if your equity portfolio is down 10 per cent or 20 per cent, are you comfortable with your asset allocation? What about down 40 per cent or 50 per cent? If the outcome is yes, stay in the seat and ride it out. If not carefully consider (with sound advice and planning) what your move should be.
Simply put; expert financial planning, being realistic about how much risk we are taking, and being careful to not take on more risk than we can reasonably bear (or more risk than is necessary to meet our needs and goals in life) is astute and prudent.
A sound, well-considered financial plan forms a part of stable robust foundation to achieve our goals moving forward and allows us to sleep well at night. Having a specifically tailored financial plan is the best choice – especially if there is an uncertain future.
Having a chat with the professionals to go over your goals and current situation is a great first step towards that financial plan. A trusted, independent adviser can offer unbiased and evidence-based advice to help you get your financial house in order.
· Bruce Jenks (AIF, JP) is a Financial Adviser at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
· The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
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