"Money, like emotions, is something you must control to keep your life on the right track."―Natasha Munson.
These are volatile times, and many analysts believe we are operating in a financial bubble created by years of qualitative easing, printing money and pumping funds into the market at negative to low-interest rates. This led to a highly leveraged global economy. However, with the rapid interest rate hikes, companies and individuals are leveraged and finding it difficult to service their debt. A case in point is the recent collapse of Silicon Valley Bank, Credit Suisse, and the First Republic Bank, which was long on treasuries. The steep hike in interest rates caused mark-to-market losses that became actual losses as they liquidated their positions to service the on-demand liabilities.
At some point, if this is indeed a bubble, it will burst, and then again, the cycle of easing and rate declines will start, but, in the process, many will be financially wiped out. The more significant economic challenges are beyond the scope of this article, and more prominent and smarter brains are finding solutions to financial difficulties. Instead, this article focuses on common investors like me who need to be cautious, feel the economy's pulse, dismantle leverage, prudently choose investment vehicles, and prioritize liquidity over risky high-return investments.
Why Should You Take Care of Your Money?
Managing your finances is crucial to leading a comfortable and stress-free life. While several financial advisors and experts can guide you in managing your money, the primary responsibility of safeguarding your financial future lies with you.Let's see why it is important to take care of your money.
1.Financial Freedom:When you care for your finances, you are not dependent on anyone for your needs. You can plan your investments and savings according to your goals and aspirations, leading to financial freedom. Reaching financial freedom has two parts: 1) Raising your earnings and saving a portion from it regularly and 2) Investing it prudently into strong underlying assets that give a good return over a longer time frame.
Financial freedom is achieved when the returns from your assets generate enough income to cover your lifestyle expenses and inflation to at least preserve the value of your principal. However, this theory is not foolproof as other factors also play a significant role in executing it. For instance, investing in companies like Credit Suisse or Enron, which were once strong but have become bankrupt, can shatter the financial freedom aspirations of investors. Moreover, the stock market is not always growing and has been on a downward trend for the last 12 months. Bonds prices are decreasing due to rising interest rates, and investments in cryptocurrency and venture capital are becoming increasingly volatile. Consequently, achieving financial freedom is no longer as simple as depositing money in a bank or establishing a diversified portfolio and earning a return. Building financial knowledge is essential to update and regularly adjust your portfolio to maintain its high quality and sound returns while accounting for unforeseen market losses.
The concept of financial freedom is aspirationaland a very good planning tool.Don't expect too much unless you are knowledgeable in wealth management. Unless you have enough money that, despite the occasional market declines spanning a year or 18 months or more, you can sustain the loss, have the knowledge to tweak your portfolio not to fall victim to collapses and have a strategy to recover the losses it will be difficult to maintain financial freedom.
Instead of expecting to earn passive income from the assets, it would be pragmatic to have a protective cushion, and you continue to do something if you are still of sound health and not too old to keep busy and relevant and earn a cash flow while doing the work that you like best.The best freedom is to do the work you like and use the time however you prefer.
2.Better Decision Making: When you know your financial situation, you can make better decisions related to your money. You can avoid impulsive spending, budget better, and make informed investment decisions. Interestingly, all the books and gurus will teach you the importance of prudent expenditure and risk management. However,the real world does not work by the book or expert advice. See how the world is working. In 2022 the most valuable asset was not stocks, real estateor bonds. It was the Rolex watchthat had the highest return.Imagine those investing in lifestyle choices did better than those who sacrificed their desires to invest in stocks or real estate.
Another observation is that big banks that made mistakes are bailed out, providing them with asafety valve, while common investors don't have any protection beyond the FDIC limit of $250,000. This says thatit 1) is better to keep your funds with big banks and 2) thedays of reaching a number in the bank and earning off it are more challenging, and it is better to live well, take care of your responsibilities, remain relevant to continue to earn through brand YOU, save and invest with a strategy andfind time, not just money, to experience the world.In the end, we will all go without money and assets. It's the experience that gives satisfaction in life. The bottom line,savings and sound investments give us more time and protection to enjoy life.
3.Reduced Stress:I have often heard that financial stress can significantly impact your mental health,and by taking care of your money, you can reduce stress levels and lead a peaceful life.I don't know if too much money reduces or gives stress. When the market is down, and you feel the pinch of even unrealized losses it gives stress. Managing stress is a whole separate science and art. The point is that having a good cushion in uncertain times provides peace of mind that some unforeseen challenges that require money could be met. Everyone should keep hold of a pot of funds for the rainy day.
4.Emergency Preparedness: Unexpected events can occur anytime, and being financially prepared for them is important. You can create an emergency fund to help you in need by managing your finances well.The case of Silicon Valley Bank provides very good learning that at any time, our on demand-assets should be higher than our on-demand liabilities. In simple words, we should have enough liquid or near-liquid assets that can cover our upcoming and some of the unforeseen liabilities.
Important Considerations
As you plan your finances consider the following points:
1.Develop financial knowledge. Understanding the market and developing strong financial acumen are important for making informed investment decisions. Let's take an example to explain the point. During the pandemic, the tech sector grew rapidly (for example, zoom stock grew 7.6 times in 10 months alone) but slowed later due to rising interest rates and the relaxing pandemic restrictions. Investors with basic knowledge of economics and finance could see that high-growth stocks would be affected more by rising interest rates and recession, while luxury stocks would be less affected. Therefore, adjusting one's portfolio from high-growth stocks to luxury, gold, and treasuries would protect funds better. Gathering information, understanding market dynamics, and using your financial knowledge to make decisions are essential.Remember, invest only in asset classes that you understand.
2.Continuously assess the risk of your portfolio.Investing has an inherent risk, which is accentuated if you become a passive investor and allow the controls in someone else's hands. The better way is to bring together expert advice, learn to build your own knowledge and closely follow the underlying assets and market you want to invest in. Passive investing in times of uncertainty with turmoil in banks and financial markets is risky. For sure more money is made in uncertainty, but it requires expertise, robust strategy, and a deep understanding of the market fundamentals.
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3.Beware! The desire for quick riches is becoming more prevalent today. Alongside this trend, attention spans are decreasing, leading people to seek fast solutions and rewards. Social media is full of self-proclaimed gurus who make predictions based on trends to attract unsuspecting investors. This has caused panic and fear based on half-information or exaggerated doom-and-gloom perspectives on events. People may make ill-informed decisions based on media hysteria without proper financial knowledge. Sustainable results require strong fundamentals and cannot be achieved through shortcuts. While unpredictable events or gains can occur, they are not sustainable in the long run. It is crucial to understand the fundamentals, avoid the media hype of investment and disinvestment, and stick to your strategy while tweaking it based on sound market and financial knowledge to avoid losing out financially.
4.It is okay to keep money in banks despite the recent banking turmoil.Nothing is for sure now. However, data shows that it is better to be withbigger bankswith a larger asset base as these have a higher chance of a bailout in the event of a collapse. The alternatives to banking are several, and these also have inherent risks. The banking system is based on fractional reserve banking, allowing banks to lend 90% of their deposits. Post-pandemic, the banks in the US could lend 100%. By design, no bank can stay afloat if all the investors withdraw their funds simultaneously. Do check with your relationship managers about the liquidity strength of the bank.
How to Take Care of Your Money?
Here are some reminders on taking care of your hard-earned funds.
1.Set Financial Goals:The first step towards caring for your money is to set financial goals. These goals can be short-term or long-term and can include saving for a down payment on a house, paying off debt, or building an emergency fundfor more mature people with wealth, an understanding of their portfolio of assets for financial freedom or a solid cushion to protect them from volatility. Setting these goals will help you focus your efforts and create a plan to achieve them.
2.Have a strong balance sheet. Like the companies, having a strong personal balance sheet is important. I mean that your equity should increase yearly, which is the difference between Assets and Liabilities. In other words, you gain financial muscles (strength) by having more assets that give you multiple passive income streams.Now, be wary that not all assets are productive. They may appear as an asset on your balance sheet but are quasi-liability. For example, purchasing and renting a property is a productive asset as it generates passive rental income. On the other hand, if you buy a property to live in it and are not renting any portion of it to generate a passive income to pay the debt then it is a liability or, best, a speculative asset on which gain is realized at the sale if the price of the property has appreciated. The appreciation net of capital gains tax has to be enough to offset the accumulated debt interest, maintenance costs, property taxes, currency depreciation, etc., for the asset to become productive.Another way to examine your primary residence is to evaluate the arbitrage between mortgage interest and rent.For a long period when interest rates were low or below zero, inmany countries such as Switzerland,it was financials better to buy versus rent. Mortgagesin Switzerlandare spread over 80 years, so in effect, you are renting by paying a principal amount with low-interest rates (I am talking of a time before the interest hike) to make an arbitrage on rent versus mortgage interest. The property is more like a liability, with the benefit being that the arbitrage opportunity reduces the cost of financing, and you can get a leveraged return on capital gains.
3.Invest Wisely: Investing your money can help you grow your wealth, but it is important to invest wisely.The vanilla portfolio diversification with some stocks, bonds and cash or real estate REIT or physical property is a good investment choice for investors who do not have the time or deep understanding of the market. However, in such a portfolio, if the common investor uses the retail bank, her cost will be very high, and she will have to pay again if she wants any change in the portfolio. The bank usually is the winner as they get their fees for investing while the investor bears the risk. The idea is to diversify risk to protect the portfolio from a major shock.Consider your risk tolerance and investment goals before investing your money.Learn and build your knowledge of finance, as all businesses, even non-profits, are run on finances.Consult with a financial advisorbut don't take anything for granted. Research and form your own perspective if you truly want to succeed.
4.Track Your Spending: Keeping track of your spending is essential in managing your finances.As you do for your company, make a personal budget, stick to it, and ensure you are not overspending in any area. You can use budgeting apps or software to make this task easier.Save from your monthly salary or profits, keep some liquid money for unforeseen contingencies, and invest the remaining in quality assets you understand well.
5.Build an Emergency Fund: An emergency fund can help you prepare for unexpected events such as job loss, illness, or a natural disaster. Save enough money to cover at least six months of expenses.
6.Pay Off Debt: Debt can be a significant financial burden, and paying it off immediately is important.Especially fully pay off your credit cards as their interest rate is the highest. I have seen some with an APR of 50%. As for your other liabilities like mortgage or borrowings, create a debt repayment plan, stick to it, and consider consolidating high-interest debt into a lower-interest rate loan.
Let's take the example of people who took variable interest rate mortgages and benefited from the low-interest rates of past years. However, with the steep rise in interest rates, they will feel the heat of additional costs. If this continues, they may have challenges in meeting their rising on-demand liabilities.
Conclusion
In my many years of nomadic life that has taken me to live in ten countries (three countries twice) in thirty-three years, I have met many acquaintances who, at some point, lost all or most of their wealth in investing. A few whom I met were wiped out by the dot.com bubble of the late 1990s; a few lost a lot in the Saudi market turmoil of 2006, many during the 2008 financial crisis, while others were more enterprising,losingtheir fortunes with day trading. Of course, you can blame an economic problem which affects everyone, for your losses during that time. Still, we see many losingor not getting a good return on theirmoney outside financial crises.
We can all lose money.I have been on the losing end many times, sometimes with unrealized losses (recovered with stock appreciation) and sometimes real losses (exited the position at a loss to avoid more hurt), at several points of my investing career, as investment has inherent risk. The point I am making repeatedly is to have a deep understanding of your finances and risks involved in investing in real estate, stocks, bonds or any other financial instrument or venture capital, along with a clear investment strategy supported by ideas for risk mitigation and monitoring. You should be able to convert decisions into numbers (70:30 is good enough to give you at least a direction). I do not favour handing your money to banks and forgetting about it. Yes, you should get the best advice from the experts. The important word is an expert, not just a salesperson at the bank or a financial brokerage firm.The bottom line is that unless you are comfortable understanding and evaluating the quality of the underlying assets you invest in, avoid getting into them.
Remember, the best person to take care of your money is you.
Waqi Munim
