In today’s volatile global economic environment, it’s more important than ever to stay focused on your financial plan. An updated financial plan will assist in guiding your actions to help you be proactive, rather than reactive, regarding changes to the economic landscape.
A financial plan can help navigate many of the issues we are currently seeing: rising inflation, rising interest rates, and uncertainty about market returns in the short term. In turn, working with your advisor to make small changes to your financial plan now, can pay dividends in terms of growing wealth for the future.
Here are a few important factors to keep in mind in relation to your financial plan in today’s economic environment:
The average cost of goods in April jumped by 8.3% compared with the prior year. This marks eight consecutive months of rising inflation and 12 months of price increases rising at a faster rate than the Fed’s 2% objective. Rapidly rising inflation has the potential to negatively impact a financial plan as the real rate of return on your investment is reduced. For example, when portfolio returns are 8% and inflation is 2%, the real rate of return is 6% on your portfolio. However, when inflation rises to 5%, the real rate of return of the same portfolio is reduced to 3%. A reduction in your real rate of return can significantly affect the long-term value of investments as the overall purchasing power of your portfolio is reduced.
Consider reviewing your cash flow planning with your advisor. The cash flow planning model can show how elevated inflation may impact your portfolio. While everyone’s situation is different, planning for elevated inflation can help bring to light any issues that may arise from increased spending in the near term. Many expenses are unavoidable, like food and gas. Other large purchases can be strategically planned for with a clearer picture of your personal cash flow situation. Working to identify alternative distribution and investment strategies -- like tax loss harvesting and adjustments to your risk tolerance -- can help offset high inflation and build long-term portfolio value through a higher real rate of return.
In an attempt to curb inflation, the Federal Reserve has begun to raise interest rates with the hope of influencing individuals to tighten their wallets and spend less money. Many large purchases provide the option for individuals to borrow money to make those purchases. When interest rates go up, the payment required to pay off debt also increases. Rising interest rates can make large purchases less desirable and change the overall economic landscape by reducing the number of individuals willing to use their own cash vs. debt to make the purchase.
With that being said, the question remains: should you take on debt or use cash to fund a large purchase in a rising interest rate environment? It is important to remember that all debt is not bad debt.
For example, if a market decline has occurred, it may be advantageous to use debt that is secured by your investment assets like a margin loan or a secured line of credit against your investment account. These types of loans can be used as short-term funding source to give your investments time to recover while still moving forward with a large purchase. Once your investments have recovered, you can pay off the line of credit in full using your investment account assets.
In terms of debt, it is best to avoid high-interest debt like credit cards or unsecured personal lines of credit to fund any major purchases as they typically carry significantly higher interest rates. Even for short periods of time, these types of loans are typically not worth taking on unless it is an emergency.
Regarding a volatile market, it is best to analyze your most conservative estimates when it comes to investment returns to ensure your plan can withstand these economic ups and downs. From there, hold strong in your investment strategy and give the market the time it needs to right the course. This approach especially rings true when markets have seen a dip in values; allowing time for your investments to recover can go a long way in ensuring a successful financial future.
Above all, think about financial planning as a long-term process. Rely on timeless principals as well as data and analysis from your financial plan to be strategic in goal-setting and avoid impulsive decisions. Remember that your financial plan should work for you in good times and bad times, regardless of market conditions. It's important to stay the course to achieve long-term financial goals and to work with your advisor to make adjustments to your financial plan, as needed.
If we can help with creating or updating your financial plan, please reach out to us for assistance.