The value of assets such as stocks and real estate increases on average over the long run.
It also tends to fluctuate in waves - it will go up for a while, then down a little, then up some more and down again.
If you are not careful these waves can make you seasick, metaphorically speaking, of course.
If you watch these cycles happen but aren't aware of how to manage your response, you could find yourself making poor financial decisions as a result or even attempting to retire shortly after a devastating economic collapse, as happened to many people after the 2008 financial collapse.
What are the ways to prevent this from happening?
YOUR TIME HORIZON AND ECONOMIC CYCLES
The main thing to consider is your time horizon - the number of years you have remaining before your planned retirement date.
When you are young and first begin saving for retirement, it is easy to take a lot of risk without worrying about CYCLICAL LOSSES, because you think you will have more than enough time to regain that value.
This is a mistake a lot of people make, as they sell all their investments when the economy crashes, forgetting that economies eventually recover.
A recession is the worst time to sell your investments because you will get the worst possible price for them, for the reason of a national economic cycle rather than anything inherent to the investments themselves.
DON'T CONFUSE ECONOMIC CYCLES WITH TROUBLED INVESTMENTS
It is important, however, that you don't confuse economic cycles with troubled investments.
If your investments are doing poorly in a strong economy, consistently underperform or otherwise give you a reason to believe that the price won't recover, then don't stay on a sinking ship - sell those investments and buy something better.
Losses resulting from economic cycles, such as recessions, will recover; so remain persistent.
After you get some practice and become familiar with these cycles, you can even sell your investments just as they begin and then rebuy them when they lose a lot of their value, maximizing your wealth.
Another approach is then to sell them again slowly as their price recovers.
This reduces some of the risk associated with the economy's uncertain movements - something which so many people struggle to predict, even experts.
If you know how to ride these cyclical waves in the economy, you can actually use them to your advantage, but even if you just hold onto your investments and wait out the recession, you will regain the value eventually.
FINANCIAL PLANNING NEARING RETIREMENT
These cycles only really pose a risk to people who are getting ready to retire in the middle of one.
This is why you should absolutely manage a shift in the types of investment you hold as you get closer to your retirement.
When you are young, more volatile investments like equity index funds will give you the highest growth rates, even though the price roller coaster may make you dizzy.
As you get closer to your retirement date, the timing of these cycles can be very unfortunate, leaving you with little money to fund your retirement; so over the years you should gradually switch from high-risk to low-risk investments.
This means that you should regularly increase the percentage of your total investments that are allocated to things like low-risk bonds, fixed-rate annuities or even high-yield bank accounts.
That way, by the time you are ready to retire, the fluctuations in the economy will have little influence on the value of your investments.
This process of gradual risk reduction will help to give you the highest returns on your investments, while carefully managing the amount of risk to which you are exposed.
No comments:
Post a Comment