Understanding Economic and Financial Cycles
Submitted by MIRUS Financial Partners on July 29th, 2019Sometimes the economy is booming. Other times it seems sluggish. In the past few decades, we've seen several dramatic swings in the economy and the financial markets. Today's faster communications and technology mean that both can get much better or much worse very quickly. We can't control the way the economy behaves, but we can control our responses to these changes.
When it comes to investing and financial markets, our instincts often tell us to do the wrong thing. Overconfidence can tempt us to buy at market highs. Pessimism tempts us to sell when the market is low.
However, successful investors don't always follow these instincts. One of the richest men in America, Warren Buffet, once said, "Be greedy when others are fearful and fearful when others are greedy."
When the Market is Going up, Proceed With Caution
As of July 2019, the market is reaching an all-time high. While a strong market is often a great time to be an investor, it may not be the best time to buy more investments. After all, in any market cycle, there is a peak. In a growth stage, the market is on an upswing, unemployment is low, and interest rates are usually going down.
Seduced by seemingly limitless stock market gains, some investors forget about caution. These people want more investments, so they buy them at a high price, called "buying high." High-priced investments may increase in value if the market continues to climb, or they may fall in price if the market corrects.
The cautious investor has a couple of smart options in a bull market:
- Liquidate some of your priciest investments and capture some gains.
- Purchase high-quality bonds to help prepare for the eventual downturn.
- Play the long game and ride out the ups and downs of the market until your eventual retirement.
When the Market is Going Down: Proceed With Caution
Once a financial market peaks, watch out for the bear market, when the economy slows down, unemployment ticks upwards, and corporate profits level out or decrease.
When the market is down, people become angry or regretful about investments that are losing value. Many are tempted to cut their losses and liquidate investments.
However, the average person is investing to meet long-term goals, such as retirement. That means that you can't react to each turn in the market. When the market dips, it's a good time to check your asset mix to make sure it still works with your goals and your timeframe.
The cautious investor has a couple of options in a bear market:
- Liquidate some of your worst investments and cut some losses.
- Purchase high-quality investments at low prices to help you increase your portfolio's value when the market eventually swings upwards.
- Play the long game and ride out the ups and downs of the market until your eventual retirement.
Look at Your Financial Life as a Long-Term Decision
Understanding the economic and market cycle is essential. It's also smart to weigh our options as the market goes up and down. But one of the first factors to consider is knowing where you are in your personal financial life cycle. How much risk are you willing to take? Do you have time to rebound if a decision results in a loss? Is your mix of stocks, bonds, mutual funds, and cash the right choice to help you meet your financial goals without stretching your tolerance for risk?
For example, if you are under 40, you still have decades until you will need your retirement savings. You can take a few more risks and allocate more to aggressive/risky investment. This makes it more likely that your balance will go down when the markets drop. But as you keep investing, you'll look to invest more when stock prices are low to help your portfolio increase in value during the bull phase.
For those who are near retirement age, you probably want to become more conservative in your investing. It's smart to protect your investments and start shifting your funds into a more asset mix. You want to create a portfolio that can resist the swings of the market. You'll make less in upcycles, but you'll also lose less in downturns.
Ready to get a professional to help you create your long-term financial plan? Contact Mirus Financial Partners today.
Want to learn more about market swings? Check out these MIRUS blogs:
Don't Count Your Chickens and Other Truisms to Remember in a Volatile Market
Investment Risk: Friend or Foe?
5 Ways to Keep Your Cool in This Market