“It’s only when the tide goes out that you learn who has been swimming naked.”
–Warren Buffett
THERE HAVE BEEN SIGNIFICANT PAPER LOSSES THIS YEAR
It has been a challenging year for the markets. Most investors have paper losses, especially in their IRAs and 401ks.
The Standard and Poor’s 500 stock index shows more than 25 percent losses. And anyone who bought stocks on their “margin credit card” has managed to make things worse.
That situation may not improve soon. On the contrary, some of the most informed opinions are that our economic situation may deteriorate further.
So, what should you do when so many successful people and companies deal with financial stress and losses on paper? There are a lot of ways to cope and adapt.
STRATEGY ONE: PAY ATTENTION TO YOUR PERSONAL FINANCIAL SITUATION FIRST, NOT THE PAPER LOSSES
It is easy to get distracted. But consider the larger picture, and take care of yourself and your day-to-day finances first.
The reason? The decline in your retirement account balances is likely to be temporary when you think in terms of decades.
If you are 20 years from retirement, you will likely go through several more economic cycles and 20 years more of saving. So, it is too early to worry, especially if you have a balanced portfolio.
If you are closer to retirement, hopefully, you have other sources of income and are diversified (see below). But the point remains the same. You do the best you can to ride the downturn out and find alternate sources of income.
STRATEGY TWO: BE OBJECTIVE ABOUT YOUR PERSONAL FINANCES
It is important to avoid panic when the market declines, but not kid yourself, either. Here are a few things to think about:
- Diversification—are your investments and income diversified? To find out more about this and to see why it matters, see here.
- Reserves and debt—Consider money in the bank as an insurance policy. While many financial advisors recommend up to six months of salary be placed in the bank for emergencies, that is difficult for most people. So, if you do not have much in the way of reserves, the next best thing is to have low levels of debt and easy (liquid) access to assets in case you need them.
- Job security—in the last post, we discussed why quiet quitting is a risk as the job market deteriorates. It is mainly a problem if you are an average performer or have no social connections with co-workers or others in your industry. To keep your job secure, avoid quiet quitting.
STRATEGY THREE: AVOID A FORCED SALE OF ASSETS WHEN YOU HAVE HIGH PAPER LOSSES
When you have a forced sale of assets at bargain basement prices, your paper losses become real. Here are some of the primary types of risk situations that can occur:
- Recent home purchases at the top of the housing market, with a subsequent forced sale. Home prices are starting to drop in some areas of the country. If you have no choice but to sell, it locks in losses if prices have declined in your area. So, many homeowners opt to rent their homes out instead of selling, especially if they have loans at low-interest rates. Owners rent out now and sell later when the market recovers. But not everyone wants to be a landlord or should be one. And in some circumstances, a forced sale cannot be avoided.
- Mandatory Required Minimum Distributions (RMDs). Sometimes you must withdraw from retirement accounts whether you want to or not. See here. That action locks in losses, primarily if you have invested in long-term assets like stocks and bonds. The key is to have other resources besides your IRAs when the market is down, to ride out a market downturn.
- Health issues. Health problems can lead to a list of unwelcome and unexpected expenses. Expenses can compound your problems if you must sell assets that have lost value to pay medical bills. So, staying healthy is an important priority. Medical bills are the number one cause of bankruptcy.
When you do have to sell assets at a loss, try to offset gains with losses, where possible. That will at least help with your tax situation if your assets are not in a tax-exempt account.
STRATEGY FOUR—LOOK AT PAPER LOSSES DIRECTLY AND CONSIDER ALTERNATIVES IN THE WORST CASE. ACT ACCORDINGLY.
Worst-case thinking is not a pleasant exercise. But when you think about the worst case, you usually realize that there are several reasonable alternatives and courses of action. And that is comforting. What we often fear most is that we will have no options at all.
For one story about the process, read here.
Ironically, I find that this exercise makes me sleep better. What you imagine is usually much worse than reality. And there are always options, even if they are not ideal.
ABOUT ME: I AM STICKING TO MY FINANCIAL PLAN. SO FAR, IT IS WORKING.
It has been a rocky year, but my net worth has increased. That is because I have done some basic financial things. I have paid down loans, increased income, accrued savings, and even had a few paper gains on real estate holdings.
None of these actions are exciting, but the result has been good.
But that does not mean that all my strategies have worked. For instance, my stock investments have not fared well because I misread the danger signs earlier in the year.
However, after having significant paper stock losses early, I have closed the gap and am only slightly worse than the market. Not exactly something to celebrate–since the indexes are all down sharply.
But I remain optimistic. So far, we have done well overall.
A BIT OF CAUTION
As I look at the broader economic picture, I am also concerned about financial damage in the markets that have not surfaced yet.
In Buffett’s parlance, someone is swimming naked, but we don’t know who it is yet. Unfortunately, someone is always out there looking at the market as if it is a gambling casino. And during times of fast-rising interest rates, those investors can be hurt badly–and cause problems for larger financial institutions and everyone else.
For instance, one recent case makes me wonder and makes me cautious. The Bank of England was busily raising rates. And then, without explanation, they recently reversed course by buying their bonds.
Everyone was mystified. It turned out that their rapid rate raising was creating problems for English pension funds. The pension managers were hedging their bets by using derivatives (yes, the same financial instruments that caused the Great Recession).
So, realize we need to be cautious at present. It will take a while for risks to surface and play out. Even prominent actors can make mistakes and put some of us at risk.
SUMMARY:
Stay optimistic. Here are the significant points to consider and act upon:
- Consider your finances first before thinking about paper losses. Temporary paper losses do not matter much in the long run.
- Be objective about your situation and know your financial strengths and weaknesses. Act on your weaknesses.
- Avoid the forced sale of assets, especially during periods when you have paper losses.
- Be objective about paper losses and work on alternatives if the course you are on is not working.
I will be back in about a month after some extended time off.
And I am bringing a bathing suit and will wear it, especially when the tide is out.
Disclaimer: consult with a financial fiduciary before taking any steps outlined here. Not all advice may be suitable for your circumstances or investment style.
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