A financial crisis is devastating for our personal finances. There is no perfect way to get ready for it, and it’s inevitable. Experts tell us that each of us will go through many financial crisis in our lifetime. Here is how to invest during a financial crisis.
Yet, there are ways to reduce their impact on our finances. This article will go over investment best practices and how to invest during a financial crisis.
What Is a Financial Crisis?
A sharp decline in asset values in a short period is what triggers a financial crisis. It’s often driven by the fear of the unknown from investors.
But when the economy is taking a hit, it also affects customers and businesses as they start to default on their debt payments.
This situation triggers a liquidity shortage. So the government has to rescue banks and businesses that are at the center of our global economy.
What Are Investment Best Practices?
Assess Your Financial Situation
Before making any investment decisions, you need to assess your financial situation. It’s a crucial step because it will help you determine how much money you can afford to invest.
You can follow these steps to assess your financial situation:
1 – Go through your bank accounts and debt to know your net worth.
2 – Calculate your average monthly expenses. Monthly expenses are groceries, debt payments, subscription services, or gas.
3 – Estimate your monthly savings by subtracting your expenses from your salary.
4 – Determine how much you can afford to invest now and monthly.
Also, keep in mind that having 6 months of expenses in an emergency fund is a great idea. Better to be safe than sorry.
Think Long Term
You need to think long-term. Even if there are many ways to invest your money, only a handful are worth it.
Don’t invest your money in real estate or the stock market if you need it in a few months.
Real estate and the stock market are great investments because they keep going up. Even if they take a hit during a financial crisis, you can expect great returns in the long term.
For example, the historical average stock market return is 7%.
Determine Your Risk Tolerance
Your risk tolerance determines how much money you are willing to lose to make a potential profit. In other words, it’s your mental ability to handle volatility.
All investments fall into one of these 3 risk categories: low, medium, and high.
Let’s take a few examples:
– Savings accounts fall in the low-risk category. You can’t lose your investment but they won’t earn you much.
– Mutual index funds fall in the medium-risk category. You invest in hundreds of companies at once.
– Individual stocks fall in the high-risk category. If the company you invest in files for bankruptcy, your investment goes away with it.
So before investing your money, determine your risk tolerance. Then you can think about your risk investment allocation. For example, low risk = 40%, medium risk = 40%, and high risk = 20%.
Rules for Investing During a Crisis
Panic is what fuels a financial crisis. Asset prices plunge because of the uncertainty around how low can they go. Investors are selling their assets based on the short term.
But if you are investing for the long term, keep following your investment strategy. You don’t have to look at your portfolio going down.
In the long term, your portfolio will go up. Fidelity found out that the best investors are people who forget their portfolios.
Don’t Invest All at Once
If after assessing your situation, you have money to invest, do not invest it all at once. During a financial crisis, nobody knows when asset prices will touch the bottom.
Your goal should be to use the dollar-cost averaging strategy to buy the dip. This strategy means that you have to invest a fixed dollar amount into an investment regularly.
So, for example, you can divide what you want to invest in 10 investment units. When the asset price you want to invest in loses X% of its value, you can buy it with one investment unit. Then if it continues to lose Y%, you can buy it with another investment unit.
Diversify Your Investments
Diversification is extremely important when investing money, especially during a financial crisis. It allows investors to reduce their exposure to a particular asset.
For example, instead of buying one rental home with your money, you can buy 3 rental apartments. This way, if you don’t find a replacement for a tenant, 2 of your apartments will still generate money.
The key to financial success during a financial crisis is to not rush or panic. The easy way to do it is to not look at your portfolio.
However, a crash can be a great opportunity to invest money by leveraging the dollar-cost averaging strategy.
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