A Look Back, a Look Ahead – Learning the Financial Lessons of 2020
During a year when COVID-19 altered nearly every aspect of our daily lives, the pandemic also put Americans’ financial preparedness skills to the test. But the lessons we learned about how to manage our personal finances are principles that stand the test of time.
And, even with the uncertainties we faced, the experiences we endured on the personal finance front throughout 2020 should prepare us well for the months ahead.
As 2020 draws to a close, what advice will serve us going forward? The lessons below – around saving, spending, borrowing and investing – are not new, but they will help you make sense of the year that was while steering you through the financial journeys ahead.
1. Build Your Emergency Fund
The financial impacts of COVID-19 highlighted that few people are immune to job losses, pay cuts or unexpected expenses. Government stimulus measures helped ease the pain, but many Americans still found it necessary to tap into savings to help make ends meet.
That calls for proactive saving practices heading into 2021:
- Make your emergency fund a priority. Saving for a rainy day remains sound advice. Why? Because the pandemic may continue to hamper many sectors of our economy. And the upcoming details related to our new administration’s fiscal policies and the legislative process that will affect them remain to be seen.
- Build at least a three-month cushion. Financial experts have always recommended saving enough to cover between three and six months of living expenses. In light of what we’ve faced and what is to come, the wisdom of this basic tenet continues to resonate.
2. Create a Budget and Spend Wisely
Prior to the pandemic, many Americans spent their income without giving it much thought. Unemployment was low and credit was readily available. It wasn’t uncommon for some people to live paycheck to paycheck.
Now, as we know, spending needs to account for saving. But it’s not necessarily difficult to make cuts. The extended pandemic showed it’s possible to give up many expenses from the pre-COVID-19 era. Line items like travel, dining out, entertainment and even the cost of owning a second car have been among the most expendable.
Here’s how to keep this momentum going in the new year:
- Make a spending plan. The drastic changes from 2020 made it easier for many Americans to see where their hard-earned dollars were going. It proved to be an opportunity to break unsustainable cycles of spending – and to develop new and improved spending habits. If you don’t yet have a plan, create one to help you stay on track.
- Let your budget lead the way. This year’s events also made it easier to redirect newly unused funds toward achieving valuable short- and long-term goals, such as saving for retirement and college education. If you’re looking for budget guidance, consider the 50/30/20 budget.
3. Don’t Try to Time the Market
Another loud-and-clear lesson in 2020: The stock market can be highly volatile and difficult to predict. And, going forward, with continued uncertainty about the pandemic and government policy, there’s likely to be more volatility yet.
Therefore, it’s a good idea to follow tried-and-true advice:
Don’t give in to panic buying or selling. Events like the widespread availability of a coronavirus vaccine or a new economic stimulus package will undoubtedly drive market movements. But trying to react to or predict the changes can be a losing proposition.
It’s wiser to stay the course. Pulling out of the market to avoid losses means you won’t be able to participate in its recovery. Which, if 2020 was any indication, could be right around the corner.
- Diversify your investments.* This is another popular recommendation that continues to make sense now and going forward. Different types of assets perform well under different conditions or at different times. Therefore, having a diverse portfolio – mutual funds are one way to get there – should help shield you from some risk, even heading into a new year and new administration.
4. Tackle Debt
With spending down this year, it’s no surprise that debt has decreased. According to the Federal Reserve, total household debt decreased by $34 billion in the second quarter of 2020. It was the largest fall since the second quarter of 2013. In addition, credit card balances fell by $76 billion, the steepest decline in the history of the data.
With household spending down, now is a great time to pay off outstanding debt. Doing so can help you save money on interest payments, while also freeing up more of your money to put toward savings.
Here are two popular options for paying down debt:
- Pay off debt with higher interest rates first. This can help you save more money, in turn accelerating the pace at which you can pay down debt. You might also find it advantageous to consolidate your high-interest debt into a single lower-interest loan, which may also reduce your debt load.
- Employ the snowball method. This strategy focuses on paying off the smallest balances first while gradually increasing your savings. The idea is that removing your debtors one by one encourages you to make even more positive changes when it comes to spending, borrowing and saving. Because this approach requires socking away savings as you’re paying off debt, you’re building up a nest egg while reducing the burden of borrowing.
Keep Striding to Improved Financial Wellness
While uncertainty about the coming months continues, 2020 will be viewed as the year when COVID-19 pressed Americans to rethink their saving, spending, borrowing and investing habits.
While these challenges aren’t likely to go away any time soon, sticking to the time-tested basics related to managing your personal finances may be the best way to weather the financial conditions to come.