Economically, the first decade of the 21st Century has been, to put it mildly, “interesting.” It’s been a bit like riding a bobsled down a Black Hills slope, scooting up the other side, going off a steep cliff, and landing softly in a haystack.
It would be understandable for small investors, looking back on the past ten years, to conclude that they would be just as well off to bury their extra cash in pickle jars in the back yard. Understandable or not, that would be exactly the wrong approach. Instead, here are a few lessons small investors should take away from the last decade:
1. Building an emergency reserve to cover living expenses for six months to a year isn’t just a good idea, it’s a necessity. Having cash available can help you ride out a job loss, get through a business slump, or avoid having to take money out of investments when their value has declined.
2. Retirement will happen, sooner than you think. Start early and be consistent in investing at least 20 percent of your paycheck in your 401k, IRA or SIMPLE plan.
3. Budgeting is not a dirty word and neither is a personal income and expense statement. Tracking your spending and creating a plan for how you will spend your income is a necessary survival skill in the 21st century. Those who choose not to use this skill will not gain and maintain financial independence. There are numerous free tools available, such as Mint.com and Quicken, to help you.
4. Understanding and managing your thoughts, feelings, and beliefs about money is as important as understanding how money works. Exploring your money history and learning to identify your unconscious beliefs about money can change your financial behaviors forever. It is crucial to gaining and keeping control of your finances and becoming comfortable using money as the valuable tool it is.
5. Avoid consumer debt. If you can afford a credit card payment after you make a purchase, you can afford to save first and make the purchase in cash.
6. A house is a home, not an investment. Don’t buy more home than you can afford, and don’t buy a home without a down payment.
7. Real estate doesn’t go up forever, and neither does anything else.
8. Price declines, even crashes, are a normal part of investing. If you are going to invest, it’s essential to understand that the value of your portfolio will fluctuate. Be prepared to ride out downturns. Selling in a down market is “the big mistake” that will cost you dearly.
9. The fundamental strategy for managing market ups and downs is asset class diversification. This doesn’t mean having money in different banks, with different brokers, or in different mutual funds. It’s about having a good balance of mutual funds that invest in U. S. and International stocks, U. S. and International bonds, real estate investment trusts, commodities, market neutral funds, Treasury Inflation-Protected Securities, and junk bonds.
10. The foundation for everything else on this list is learning to live on 70 percent of what you make.
The final point may sound unreasonable or even impossible for anyone who is just starting out, raising a family on a limited budget, or getting by from month to month. Certainly, it isn’t easy. But one of the most valuable financial habits anyone can develop, beginning with the very first paycheck, is to save something for the future instead of spending everything that comes in.
It’s ironic, but the most important financial strategy for the 21st Century may be plain, old-fashioned frugality.
