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March 2, 2020
I’m not one to say the sky is falling AT ALL. But I am a realist, and considering the headlines and the current financial climate, I think it’s important to look at the mistakes of the past and avoid them in the future.
No matter what happens with the economy (now, or ever) there is absolutely zero penalty for being financially prepared!
So, what is the current state of the economy? Well, the S&P 500 at historic highs- it’s actually at the highest it’s been in 18 years. Simultaneously, interest rates are the lowest they’ve been in 3.5 years. This is making a lot of people nervous because these are usually indicators of a coming correction to the market. But there’s really no need to worry if you take steps to prepare for any financial swing. And to do that, it’s important to look at the mistakes people made in the past. So here are my top 5 mistakes that people made before the last recession.
What we saw leading up to the recession was people using home equity to fund their lifestyle. This was a huge mistake because when the market crashed and their home equity was gone, they had a ton of debt and nothing to secure it with.
It’s so easy to fall into this trap- I’ve seen it so many times and because of that, I developed the Smart Budget Guide (which you can download for free HERE) to help give people easy parameters to help them set up their finances and stick to a budget.
So what are those parameters to help keep you away from living on credit? You need to budget for 70% of your net take home pay to go towards your living expenses, and of that, your housing payment should be between 30-50%. This is not a mortgage guideline, but this is what I find to be successful for most people.
The remaining 30% of your net take-home pay should be going to principal debt reduction. This 30% should be working for you by reducing debt and building assets.
“Earned income” is the thing you show up to work and do. It’s the thing that requires your time to get paid for. The problem with this is that your earned income can dip along with the economy. If your earned income is your ONLY source of income, and then you loose your job, or have hours cut, or commissions decreased, etc., this puts you in a difficult financial position.
However, if you have multiple streams of income, you are able to easier ride the tide of a changing economy. Other streams of income (aside from earned income) could be from rental properties, side hustle, royalties, etc. (I actually recorded a video on this way back when if you want to learn more about this)
Similar to the concept of relying solely on earned income, if your investments are all in one thing, you are more subject to how a rising or falling market will affect that one thing. But if your investments are spread out over multiple types, you won’t be as impacted if one area fails.
Another tip I like to give (especially as it relates to housing) is that you should never invest on what you think the appreciation of whatever the asset will be. What you want to do is invest in cash flow. This is the idea that you should invest in multiple things to create income streams to compound upon each other. If your assets DO appreciate, great! But the appreciation of those assets should not be the thing you are relying upon to make the investment worth it.
We already touched a little bit on this in mistake number one, but this is something that deserves it’s own point. SO many people made this mistake in the recession: They cashed out equity in a home or some other asset, paid off debt with the cash, but then ran debt up again before reinvesting and building up that equity again that they had borrowed against. Please, DON’T DO THIS TO YOURSELF!
It’s really important to keep your lifestyle budget to 70% of your income and try to pay off as much debt as possible with 20% (the remaining 10% should go to savings) so that in case you do fall into hard economic times, you have fewer debt payments to worry about.
I talked about this concept a lot in last week’s video, and it’s important to talk about how it plays into avoiding the mistakes from the past. You’ve heard me preach this over and over, but consistency really is key.
Financial storms come and go, and planning a long term financial strategy can help you weather them. Even though professionals can give predictions, it’s impossible to say for sure what will happen. So investing consistently over time, paying off debt consistently over time, and managing your finances consistently over time is absolutely the best strategy that will give you the best results..
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