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It’s no secret that the first half of 2022 brought many expensive changes for consumers:
- The S&P 500 index fell 20.6% in its largest first-half drop since 1970, dragging investor portfolios down.
- The Federal Reserve approved a 75 basis point rate hike in June, the biggest move since 1994, making it more expensive to borrow.
- Meanwhile, newly released data from June shows that inflation was higher than expected, jumping 9.1% year-on-year at the fastest pace since 1981 — meaning many of the products and services people buy are more expensive.
As we enter the second half of the year, many investors may be wondering, “Now what?”
“It kind of feels like there’s no good move,” said Dan Egan, vice president of behavioral finance and investing at Betterment. “We’re reaching a really interesting turning point ‘how good people feel’.”
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The good news is that we may be underestimating our adaptability, said Michael Liersch, who has a PhD in behavioral sciences and is chief of consulting and planning for Wells Fargo Wealth and Investment Management.
“Even though we may be resistant to change or want to minimize uncertainty, when those things happen, we tend to adapt very quickly,” Liersch said.
Still, investors would be wise to avoid major financial changes at the wholesale level that they may later regret. But there are three moves that behavioral finance experts say you’ll thank yourself for later.
1. Use cash as a ‘dimmer or dial’ at risk
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The biggest favor you can do for yourself right now is to rethink your money allocations, experts say.
There is an important reason for this. As the market bottoms, setting aside a cash buffer can make you feel better about your personal financial prospects.
If you put all your money into the market, you may find a time when it feels so unsafe that you’re tempted to back off, Egan said. Say you have $100,000 and instead allocate $20,000 in cash, you’re going to invest the remaining $80,000 more consistently and effectively because you know your short-term needs are being met, he said.
In behavioral finance, this ability to treat different money buckets differently is called mental accounting.
“By using those mental bills to give yourself a lack of stress, a lack of anxiety about what the market is doing, you can actually be a better investor,” Egan said.
The big advantage for many people now is that risk is not an on/off switch, says Liersch. “Having cash is what helps people see cash as a dimmer or dial rather than an absolute,” he said.
While there are certain guidelines for how much money you should have set aside, it helps to personalize this by making your own estimate, he said. To do that:
- Take a look at your spending over the years and be very honest, he said. Ideally, this includes pre-Covid outflows to really get a realistic picture of where your money has gone.
- Next, ask yourself if you have the savings you need — or access to a line of credit — that will help you get through a protracted emergency.
- With that, determine how much spending was essential and how much discretionary, and where you might be able to find room to increase your cash reserves.
2. Make emotional decisions by an impartial party
Experts usually warn that when emotions run high, you’re more likely to make expensive financial films, such as panic-selling investments.
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With that in mind, if you’re preparing to make a big financial decision right now or want to change your investment strategy, try to execute it first by someone impartial, Egan recommended.
If you’re embarrassed or uncomfortable doing so, ask yourself what it says about the decision you’re hesitant to share. That could be a sign that it’s not a good idea.
It’s now also a great idea to bring in other family members to discuss how to make money work better together, Liersch said. Many people care for or depend on money from other family members, and discussing those responsibilities openly can help smooth out expectations, he said.
If you are determined to take action, small movements can help you feel some relief. That might involve taking some of your invested assets and turning them into cash or following a tax loss harvesting strategy as markets fall, Liersch said.
3. Look from a long-term perspective
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Just as grocery shopping when you’re hungry can lead to unhealthy decisions, the same goes for spontaneous financial choices, says Egan. It is important to create a plan that you can stick to.
So if you’re considering putting together a down payment for a home, focus on how you can prepare to reach that goal in six months and what steps you need to take to reach your goal. With your investments, it helps to remember why you’re putting the money aside, whether it’s raising a child or your own retirement, rather than getting caught up in day-to-day gains or losses.
“One of the fundamental things about human decision-making is that we find it easier to be smart and virtuous when making decisions about future costs,” Egan said.
It also helps to turn off the automatic news and market updates on your phone and see a longer-term perspective, he said.
For example, if you go back to the front page of a newspaper from 1969 or what happened on this day in 1856, you will see that people had a lot of problems to worry about.
“The names of things change, but the fundamental reality of being human does not,” Egan said.