“A goldfish grows to the size of its bowl!” This commonly known adage is used to encourage people to expand their horizons by widening their self-limited beliefs. However, the true reason that goldfish in a tiny tank stay small is lesser known. Goldfish are “indeterminate growers,” meaning they grow for their entire lifetimes. The determining factors for how large or small a goldfish develops relates to the health conditions within the tank–if the water is unclean and the fish is releasing stress hormones, it will stay small. Goldfish thrive and grow in conditions where the water is clean and they can mitigate stressful conditions.
During this Covid-19 pandemic, many of us may find ourselves in smaller tanks than we’re used to. Whether you’re teleworking from home or from a secure office, it’s fair to admit that today’s work environment has shifted in an effort to reduce the spread of the virus. Learning how to work in a new way can be stressful, and this stress for many has been intensified by a currently volatile market and an unknown state of the global economy.
Today we’re going to dive into seven financial fundamentals that are always important to focus on, but that have become especially significant during these trying times.
1. Cash Reserves.
We always recommend having an emergency fund of liquid assets set aside that can cover living expenses for unforeseeable situations, such as the present one. This is to protect yourself in case you get furloughed or let go and are left with less of an income (or without one entirely).
The standard rule of thumb is to have 3-6 months worth of cash on hand at all times. However, depending on what industry you work in and your typical status (part-time vs full-time), you may need even more. For instance, business owners or freelance workers in an industry which depends on in-person interactions, such as the entertainment industry, should aim for 9-12 months (or maybe more!), while full-time workers in an industry less prone to disruption, like tech professionals, can likely get away with less.
You might be wondering why your emergency fund should be in cash instead of as part of your investment portfolio. Fair question. Whether you’re in retirement or still accumulating, we want to protect you from having to sell your investments to fund your lifestyle when the market is down. That’s what the reserves are intended for. Sometimes that’s just not possible, though, so if you do have to sell, try to limit selling the stock portion of your portfolio. It’s usually better to sell the fixed income portion first. Not only is it less likely to be down by as much as the stock portion would be, but it also gives the overall portfolio a chance to recover faster post-market downturn. And if you don’t have a fixed income portion to your portfolio, this is one of the many reasons to add one.
2. Don’t panic sell. (It’s OK if you already did.)
The tendency when one sees their portfolio taking a dive is to sell. Outside of needing spending money, as noted above, do your best to resist that urge. Many people who sold their stocks in the pit of the 2008 Financial Crisis missed the upside swing that came on the other side. It’s important to maintain a long-term growth mindset right now and understand that this current situation is only temporary.
If you already sold off any stocks, bonds, or mutual funds, that’s alright. Just make sure that you reinvest as soon as you have enough cash to cover living expenses to ensure you gain from the growth that will come in the long run.
When you are ready to invest again, our philosophy is that you should implement a globally diversified portfolio. Global diversification means investing in more than just the S&P 500. We’re talking US stocks, international stocks, emerging markets, small-cap, large-cap, value stocks, growth stocks, the works. Ideally, you’re doing that with low cost index funds, which could be in the form of mutual funds or ETFs. In doing this, we want to spread the risk across thousands of companies and other markets to lower volatility and give your money a higher probability of steady growth.
3. Diversify Income Streams.
As we’ve alluded to in the past, turning your human capital (aka earning potential) into financial capital is one area of your personal finances that you can control. Since you’re hopefully spending most of your free-time sheltering-at-home these days, this could be a great opportunity to invest some of that time in building a side hustle or pursuing that passion hobby you’ve been considering to boost your total lifetime income.
Developing multiple streams of income comes with the added benefit that if you lose one, you still have other ways of making money to fall back on. Talk about recession-proof. So our advice (and Mark Cuban’s): take out your dream journal, do some market research, and start making this new venture a reality, especially if it can be online and does not depend on physical, person-to-person interactions.
Bettering yourself with passion hobbies or investing in your education could also make you more valuable when it’s time to go back to work. You’ll have developed new skills that will not only increase your hireability, but will also allow you to demand a higher salary in the long run.
For most of you, there’s no need to be productive all the time during this difficult period. It’s important to balance self-care, family time, and play time into the schedule. That said, this is a unique opportunity to carpe diem if there’s a skillset you’ve been considering learning more about. It doesn’t even need to be something you spend all day on. For example, if you read just 10 pages per day, in 30 days you’ll have read 300 pages. That’s a book per month. Break it down into bite-sized chunks, and the progress will come over time.
4. Limit Expenses.
Remember our little goldfish friend from the analogy at the beginning? If the parameters of your life have changed, you need to prioritize living within your current means to maintain a healthy tank, or in this case a healthy bank account and headspace.
It’s okay if you’re not able to contribute as much (or anything) to your savings at the moment. Much of the world is in the same boat as you. What is important now is to do your best to avoid having to dip into accounts where you put your future at risk.
This is also a good time to practice Minimalism, if you’re not doing so already. That could look like:
- Cooking instead of ordering out. Look up some online recipes if you’re bored of your repertoire. Take out that slow cooker you’ve been meaning to use. (Highly recommended that you clean it first, or use liners.) But it’s a game-changer for cheap and easy meal prepping.
- Cut out subscriptions that are inessential.
- Look to cut your gym expenses (if your gym is still charging you). Many gyms are allowing clients to freeze membership without the typical costs and fees incurred when pausing one’s account. Instead, you can Youtube yoga, or find a friend to do a Zoom workout with. Being isolated doesn’t mean you have to be alone, not in our modern world.
Getting used to your fish bowl at this new size will put you in a better position when the world reopens and you’ve grown accustomed to living on a leaner budget. That’s a win-win.
5. Pay Attention to Taxes.
The elephant in the room at the moment is the stimulus rebate check. Even though the income tax deadline has been extended until July 15th, you’ll want to be conscientious of how the timing of filing impacts your eligibility to receive the stimulus… For example, if you made enough money to disqualify you in 2019 but you would qualify with your 2018 income, wait to file. They’re sending out that money based on your most recent filing, which, by waiting, would be 2018. On the other hand, if 2019 was a lower income year than 2018, then get your taxes filed as soon as possible and you’ll be in a better position to receive that check with the next wave that comes out.
Aside from the rebate, which could help any acute financial duress, there are potential longer-term tax benefits to the recent market drop.
Roth Conversion of Traditional IRA Accounts
Now may be a good time to consider converting all, or part of, your Traditional IRA to a Roth IRA. If this is a lower income year for you, you’ll be able to do the conversion at a lower tax bracket than normal (potentially even paying no tax at all if you keep your total income + conversion amount underneath your deductions).
At the same time, the value of the account is likely lower than it has been. Since we expect the investments within the account to grow again in the future, you could save yourself in total lifetime taxes by paying some of those taxes now and cashing in on the future growth tax-free.
Let’s look at an example. You had $10k in your Traditional IRA, but with the market drop, it’s only worth $7k now. If you do a Roth conversion, you only have to report $7k of income on your tax return this year. It never feels great to pay taxes, but let’s say that by the time you make a qualified withdrawal from the Roth account, it’s grown to $15k. Had you not made the conversion, you would’ve paid taxes on the full $15k (maybe even at higher a higher tax bracket than you are today). But because you took advantage of your current situation and converted, you don’t have to pay taxes at all. That just saved you from owing tax on the $8k growth since you made the conversion.
Tax Loss Harvesting in Taxable Accounts
But what can you do If your investments are in a taxable account, such as a standard brokerage account? Something called Tax Loss Harvesting, which we do for our clients during times like these. Tax loss harvesting is when you sell an asset at a loss to take advantage of the tax laws. You then buy another investment that’s similar, but that won’t trigger a wash sale violation with the proceeds.
In the tax code, capital losses are first used to offset capital gains, both in the current year and in the future. So by taking the losses now, you’ll have some losses to offset future capital gains when you need it.
Even more “exciting,” though, is that every year, you’re allowed to take up to $3,000 in capital losses to offset your ordinary income. What that means is that if your typical income is $50,000/year and you have total net capital losses of $3,000 (capital gains minus capital losses), this would bring your adjusted gross income (AGI) down to $47,000. If you have unrealized capital losses, it’s worth harvesting at least these $3k of those losses to offset your ordinary income every year.
6. Don’t Be Afraid to Ask for Help.
There’s a story about a drowning person who was on the roof of a house in the middle of a flood. Each time a person would come by to assist them back to safety, they would decline because they were waiting for “fate” to save them. Again and again they denied helpful strangers, until eventually they drowned. Sad story, right? The lesson is that each of those people offering help was a part of their fate. It can be challenging to accept help, to show our vulnerability, but when we learn to accept the hand of our fellow people, we give them the gift of being able to share their efforts, and we get the added benefit of the boost we need.
Right now, the government is hard at work to offer aid to individuals and businesses affected by COVID-19. While everyone’s comfort and knowledge levels around personal finances are different, it would be wise to at least learn what the current options are, and how you could take advantage of them should your situation necesitate.
For one, you are able to take out higher 401K loans than usual. Under normal circumstances, you’re allowed to take loans up to $50,000 or 50% of the account balance, if it’s below $50,000. Under the CARES Act, the limit is increased to $100,000 or 100% of the balance, if it’s lower, and you get to suspend loan repayments until next year. You also have six years to repay the loan instead of the normal five.
Secondly, the IRS is currently waiving the typical 10% penalty fee for early distributions from retirement accounts (up to $100k) and is giving you three years to pay these back without penalty, as long as it’s a coronavirus related distribution. There are some finer details that you’ll want to make sure you’re aware of, but the major catch is that if you have not paid it back after three years, you will owe taxes on that distribution.
Thirdly, unemployment is an option right now for both individuals and small businesses that would not typically be covered by the program. This includes freelance workers and business owners. The government has assigned an extra $600 per week to go to those who qualify for this expanded package. Keep in mind that unemployment benefits are taxable, but it’s a great option for those who are currently without an income.
All the options above, while giving you access to money that you may need in the short term, have longer-term ramifications to your financial plan. Please don’t be afraid to embrace your fate and ask an expert for help if you are unsure how these might affect you, personally.
7. Help Others When You Can.
Financial or otherwise. When masses of people are worried about their current situations, we can do our best to assure our actions create positive consequences. It can be as simple as not hoarding toilet paper.
If you can donate financially to any struggling people or organizations at this time, it would not only boost your overall state of well-being by connecting with your community, it can also be a tax write off. You can now get an above-the-line deduction of $300 for charitable contributions. And if you’ve donated at a value above $300, you can continue to write off those contributions as an itemized deduction. Either way, it helps others and also gives you a tax break.
Many of us may feel helpless in these circumstances, despite our desire to help out. If you were fortunate enough to make more money in 2019 than in 2018 and received a stimulus check, consider how using that stimulus check to benefit your community could bring intrinsic rewards. It’s a great opportunity to test the waters in philanthropy, and could bring you deeper connections to a cause that you care about.
As we navigate this new landscape, it’s important to maintain the perspective that even if life does not go back to exactly how it was before, we are inherently adaptable creatures. We can do our best to take care of our ecosystem by practicing patience and making conscious choices for the betterment of ourselves and those in our communities. By utilizing the tips we discussed above, you give yourself a better shot at weathering any future downturns. As Dory put it, “Just keep swimming,” and we’re here to swim alongside you.