Plan Performance Direct

Financial Planning

Balancing your investments in times of turmoil

In these trying economic times, don’t be surprised to find yourself in a situation where you went from feeling confident about the economy, your income, your job and having major financial prospects for the future to all of a sudden being swallowed up by fear. There is some newfound financial uncertainty given the new realities created by the COVID-19 virus. It’s critically important to pause and evaluate your money situation. I understand the alarm looking at an investment account statement that suddenly plunged, or worrying about cash flow over the coming months, and we work to provide sage guidance through these trying times and urge caution before making any rash financial decisions. Balancing your investments can be a skill.

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Given the sudden severity of the COVID-19 virus and economic shutdown, it’s easy to put money on the back burner and not think about it. Don’t. Take this opportunity to really reflect on your finances. Your short-term money and finance decisions are critical due to a multiplier effect that happens over the long term. If you make great weekly $50 decisions when you are 20 years old, quality $500 monthly decisions in your late 20s, thoughtful thousand dollars in your 30s and superb quarterly $5000 in your 40s and 50s – you will have a lifetime of additional net worth, safety and economic stability.  But it takes time, patience and discipline to do this correctly. If you’ve done those small money decisions properly, saved those amounts when available and invested wisely, it can be the difference between huge financial success or complete failure over decades of time. A definition of money success is investing wisely, saving on a continuous basis and doing this over a long period of time so that you can provide a cushion for yourself and your family when troubled economic times arise.

The average tax refund check is around three thousand dollars. What should you be doing with it? What’s the best plan of action in light of everything that’s going on with the economy?

I bet you were expecting me to give you a concrete answer here that works for all households. Of course, the answer is “it depends”. Given that everyone is different I will provide some guidelines on the first thoughts I would like people to have when considering saving. If you get a refund check from the government, and you are currently carrying an existing credit card balance that you have not paid off, it’s our advice typically to pay off that credit card balance first and knock down or eliminate those high interest charges. Rarely, if ever, can you find an investment that will earn as much as the massive amounts of interest credit card companies charge you for outstanding credit card balances. So, for those people who have credit card balances, take your refund and pay off your credit card balance completely, if possible. Exceptions could be zero percent interest credit cards and/or no interest cards for purchases of appliances etc. as those types of debts may be okay to put off paying down immediately, but be sure to know the exact terms of your zero percent interest debts.

If you find yourself without a credit card balance, explore your current safety net. Depending upon the kind of job you have and how consistent your income is, we would recommend somewhere between three to six months of your current existing expense needs set aside in cash. For example, if you find yourself spending $3000 a month, your income is consistent and regular given the type of job and industry you work in with steady employment, you could get by with three months of cash savings. However, if your employment situation is less stable and your income is not as consistent, you’re going to want to have six months worth of cash on hand to meet your expenses. Given the sudden job losses created by the COVID-19 virus, people are finding they didn’t have enough money set aside in their rainy day fund, and this may serve as a reminder to many to not put off saving for a later date.

If you find yourself with no credit card debt and ample short-term cash savings, we would suggest bolstering your investment accounts. The first investment account type to consider would be the long-term investment account – your retirement account. Typically, a retirement account is offered through your employer, so we would look there first to make sure you are using it and getting the full benefits like employer match. The other type of investment account is money that you save outside of your retirement in what we call a taxable account that could be an individual account in your name, joint name with a partner or Trust account. All of these investment account types are equally important as a retirement account, but they can help serve a dual purpose. We find that people often focus on their retirement plan accounts, and use them to help prepare for retirement while getting some tax advantages today. Yet, we find not enough people are saving outside the plan in taxable savings accounts on a regular basis as these account types now offer excellent tools to help reduce the amount of income tax you have to pay with automatic tax loss harvesting and other neat tools designed to mitigate annual tax impacts. We encourage our clients to strike a balance between both the retirement accounts and your taxable investment accounts, as the taxable accounts can not only be used for the long term retirement objectives, but also can be available for short term urgent needs that arise. Taking money out of retirement account for emergencies can trigger negative tax consequences, whereas taking money out of a taxable account is usually easy to do and doesn’t carry tax penalties for early withdrawals. Thus, the dual advantage of taxable accounts!

Having a bunch of money in retirement is excellent and we love the tax deductions they can provide with deductible employee contributions. Don’t forget that your retirement account grows (hopefully) and no taxes are due on that growth each year. Keep in mind that the way retirement plans are designed you get the tax breaks now and you pay taxes later on down the road in retirement as you’re taking money out of your own retirement plan. This kind of tax deferments is a powerful tool to help grow your money.

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Taxable account works very differently. You’ve already paid taxes on that money, and you’ll pay taxes on the dividends, interests or capital gains each year to the extent you have dividends and capital gains. But don’t let that scare you off. There are a lot of great ways to manage your taxable account efficiently.

Our recommendation is to utilize both of these investment account types rather than just one. The reality is we see people all the time who lack balance with a high 401k balance and money set aside in a taxable investment account, but no rainy-day fund to help through the tough times. Or they will have some other type of combination rather than a balance of the three account types. We recommend a taxable account that’s flexible, liquid, invested for the long term and available if you need it. We recommend saving in a retirement plan to the best of your ability to get tax deductions today and tax deferred growth for the long term. We recommend a savings account to meet daily needs with a cushion if the unexpected pops up. You’ve got to have it all. Without them all, you’re unbalanced.

How do you decide how much money goes in which account?

It’s tricky and it’s not the same for every person. If you find yourself with a hefty retirement plan but no taxable accounts or savings, consider a taxable account. If you find yourself with more of a taxable account vs. retirement account, we would have you lean more heavily towards balancing it out, because in a perfect world, we would want people to have equal amounts of both taxable and retirement, with three to six months in cash inside their savings account. In fact, striking that balance between all three – that’s the golden key.

For more information and resources on balancing your investments or COVID-19, see our coronavirus page. Feel free to contact your Henry+Horne tax adviser with any questions.

Michael Carlin, AIF®