It’s been hard to ignore some of the massive returns seen in the financial markets over the past few years. Be it cryptocurrencies or meme stocks, the idea that you can double, triple, or quadruple your money in a matter of days or weeks can be extremely tempting, but is akin to gambling. Behavioral finance teaches us that we as investors are not always rational. We can be overconfident or react without thinking things through, which can cause us to lose sight of our financial goals. Long-term goals, like retirement savings, are built on your money decisions made today. The below three short-term goals are no different, but keep in mind that your risk appetite and return expectations should be tempered.
Building Your Emergency Fund
Any time we can automate a process, we should. We set up our bills for autopayment so that we don’t miss a payment, we schedule prescriptions so that we don’t run out of medicine, etc. An emergency fund can be set up just as easily – your bank or broker can schedule an automatic contribution of say, $50, to a savings account. It’s no different from paying a bill or subscription fee, only in this case you’re paying yourself. By doing so, you build a cash cushion of three to six months’ worth of expenses. Then, if you’re faced with an unexpected emergency, you can avoid dipping into your retirement savings or taking on high interest credit card debt (see below!).
Paying Down Debt
Not all debt is bad – you may take out a mortgage to buy a home, incur student loans for college, or unexpectedly need a new set of tires for the car you drive to work each day. But the amount you borrow may differ significantly from the amount you end up paying if you don’t pay attention to the interest rate on the debt. What may seem like an insignificant amount can easily be much more if you’re only making the minimum recommended payments. Just like automated saving, you should automate your bill payments for as much as you can afford. Ideally you should pay off debt at the end of each month, but if you can’t, then focus on the higher interest debt first, then work your way down.
Saving for a Down Payment or Other Large Expense
If you expect to have a large expenditure in the coming years, remember that stocks are risky assets. You may love them, but they won’t always love you back. Buying a house is one of the largest purchases we’ll make in our lives. It also comes with a great deal of emotional attachment, as you dream about things like raising a family. With the stock market posting above average returns for the past decade and cash savings rates near zero, it can be tempting to think that the smart move might be put your cash down payment in equities. But we’ve seen markets correct by 20-30%, which can dramatically reduce the amount of your down payment, and by extension the amount of house you can afford or debt you need to incur. It may seem like throwing money away in a savings account now, but the alternative may be much worse if the market dips and you need to pay even more.
It’s important to maintain the connection between how much risk is appropriate for your financial goals. Past stock market performance is no guarantee of future performance and regret or “fear of missing out” are powerful influencers that can sway your decision-making. A potential investment that may have a great future may also have a volatile next few years that you may not be able to tolerate. Meeting with a financial advisor to discuss and review your goals can help to keep you on the right track with the proper amount of risk.
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