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It’s no secret that the first half of 2022 heralded many expensive changes for consumers:
- The S&P 500 Index fell 20.6% in its biggest first half since 1970, dragging investor portfolios down with it.
- The Federal Reserve approved a 75 basis point rate hike in June, the largest move since 1994, which makes renting more expensive.
- Meanwhile, newly released June data shows that inflation has been hotter than expected, rising 9.1% year-on-year at the fastest pace since 1981 – meaning many of the products and services people are buying are more expensive.
As we enter the second half of the year, many investors may be wondering, “What’s next?”
“It kind of feels like there’s not a good move to make,” said Dan Egan, vice president of behavioral finance and investments at Betterment. “We’re really hitting an interesting ‘how good are people feeling’ tipping point.”
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The good news is that we may be underestimating our ability to adapt, says Michael Liersch, who has a PhD in behavioral science and is head of advisory and planning at Wells Fargo Wealth and Investment Management.
“Even if we want to resist change or minimize uncertainty, we adapt very quickly in such cases,” said Liersch.
Still, investors would do well to avoid making big financial changes that they might later regret. But there are three steps that behavioral finance experts say you’ll thank yourself for later.
1. Use cash as a risk factor
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The biggest favor you can do yourself right now is to reconsider your cash allocations, experts say.
There is an important reason for this. When the market bottoms, putting aside a cash cushion can help you feel better about your personal financial prospects.
When you put all your money in the market, you might find a moment when it feels so uncertain that you’re tempted to pull out, Egan said. Say you have $100,000 and invest $20,000 in cash instead. You’ll invest that remaining $80,000 more consistently and effectively because you know your near-term needs are taken care of, he said.
In behavioral finance, this ability to treat different bundles of money differently is called mental accounting.
“If you use these mental accounts to give yourself less stress and less anxiety about what the market is doing, you can actually be a better investor,” Egan said.
According to Liersch, the big lesson for many people is that risk is not an on/off switch. “Having cash helps people see cash as a dimmer or a dial rather than an absolute,” he said.
While there are specific guidelines for how much cash you should have set aside, it helps to personalize this by creating your own estimate, he said. To do that:
- Take a look at your spending over the last few years and be really honest, he said. Ideally this would include pre-Covid drains to really get a realistic sense of where your money went.
- Then ask yourself if you have the savings you need — or access to a line of credit — that could get you through a prolonged emergency.
- Use this to identify how much spending was necessary and how much discretion was needed, and where you may be able to find room to increase your cash reserves.
2. Run emotional decisions through an impartial party
Experts usually warn that when emotions are high, one is more apt to make expensive financial films, such as panic selling.
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So if you’re preparing to make a big financial decision now or change your investment strategy, first try to have someone who would be impartial make it, Egan recommended.
If you’re embarrassed or uncomfortable, ask yourself what about the decision you don’t want to share. That could be a sign that it’s not a good idea.
It’s also a great idea now to get other family members involved to discuss how to make money work better together, Liersch said. Many people either provide money from other family members or depend on money from them, and openly discussing those responsibilities can help balance expectations, he said.
When you are determined to take action, small steps can help you feel some relief. That may include taking some of your invested wealth and turning it into cash, or pursuing a tax loss-winning strategy while markets fall, Liersch said.
3. Take a longer-term perspective
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Just as grocery shopping while hungry can lead to unhealthy decisions, Egan says the same is true of spontaneous financial decisions. It’s important to make a plan that you can stick to.
So if you’re thinking of putting down a down payment on a home, focus on how you can prepare to reach that goal in six months and the steps you need to take to reach your goal. When investing, it helps to remember the reason you are putting the money aside, whether it’s for a child’s education or your own retirement, rather than getting caught up in daily 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 take a longer-term perspective, he said.
If you go back and look at the front page of a newspaper from 1969, for example, or what happened that day in 1856, you will see that people had many problems to worry about.
“The names of things change, but the basic reality of being human doesn’t,” Egan said.