We are still early in the fight with COVID-19, but the rapid economic changes caused by the virus have already taught us a few critical financial and business lessons.
Risk in our investment portfolios
The massive stock market volatility of the last couple of months has shown many people that their risk tolerance is far lower than the arbitrary number they filled out on their investment-policy statement. Now that you have been on the roller-coaster ride, you can quantify your risk aversion. Spend some time thinking about whether your equity or other risk-investment allocation suits your investment objectives and if the potential volatility of these holdings is appropriate for your risk tolerance.
Keeping emergency cash
Standard investment advice has always been to keep a few months of cash to cover living expenses such as mortgage payments and groceries in the case of an emergency. Many people did not heed that advice and are now struggling to make their monthly payments. Now I expect people will make building a reserve of emergency cash funds that can last much longer periods a priority.
Watch the lifestyle creep
It’s easy to get caught up in “lifestyle creep,” where people expand their lifestyle and spending alongside their increasing salary or income. Lifestyle creep is rearing its sinister head during this crisis. So while your salary, dividends, draws, etc., stop or are cut back, many expenses are fixed and seemingly laugh at you from the credit-card statement. Things such as monthly payments for fancy cars, mortgage payments for our larger-than-necessary homes and lines of credit for inflated personal expenditures are stark reminders of our excessiveness.
While our excessive fixed costs torment us, some of our discretionary expenses have ground to a halt while we are isolating at home – restaurants, clothing purchases, vacations and toll-highway driving to name just a few. You quickly realize how much money you can save on these expenses when you have no bills related to them for a month. This is a sobering experience, and I would expect many people will scale back on some of these non-essential expenses from now on.
Budgeting
Most people would rather have a root canal than prepare a budget. However, with your income reduced, evaporated or uncertain, a budget will help you understand what funds you need to pay for the fixed costs discussed above. Does your current reduced income, government benefits and savings cover you for the next few months, six months or year? If you have lost your job or now receive a reduced paycheque, how long will you need to defer mortgage or other payments? While long-term planning is uncertain in this environment, you can reduce your fixed costs over time by reviewing the savings available and restricting discretionary spending.
It has never been easier to gather the data for a budget. Pick a 30-day period from when you started self-isolating and summarize all payments on your credit cards and all automatic debits and cheques written on your bank account. This will be the foundation of your budget. You can then layer on one-time expenses not covered in the 30-day period and discretionary expenses. There are several online budgeting tools to assist you. I suggest this process is vital to your financial health and everyone should do it.
Business concentration risk
COVID-19 has hit small business owners very hard. Not only has their short-term income been devastated, but many of the retirement dreams have been delayed or derailed. The crisis has crystallized the risk of having their retirement funding concentrated on one major asset: their business.
Many small-business owners will now have to rebuild their enterprises over the next few years. Some will likely never receive the payday their retirement was premised upon.
The best-laid plans of mice and men oft go astray
COVID-19 has affected many facets of life – from family vacations, to renovation projects, to business plans for expansion and growth, to retirement plans – all have been altered, set back or permanently impaired.
This crisis has taught us some financial lessons we would have preferred not to have learned. But as we inch closer to resuming normal life, perhaps a silver lining is that if we implement some of the above lessons, the next downturn will be a little less painful.
Mark Goodfield CPA, CA, is a partner in Wealth Advisory for BDO Canada LLP.
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