Earlier this week, I came across a magazine article from the B.C. era—before coronavirus. The article, which appeared in a recent issue of a popular personal finance magazine, described a certain type of bond investment. The write-up was well researched and balanced, including a discussion of the risks. Among them, the author raised the possibility of an economic downturn. Here’s how he assessed this risk at the time: “Recession, as always, is a risk,” he wrote, “but where’s the recession? Not seeing it, friends.”
That was in February. I can’t blame the author for so easily dismissing the risk of recession. Anyone would have done the same thing. After all, unemployment was at a 50-year low as recently as two months ago. But since then, everything has changed. In the past five weeks, twenty-six million Americans have filed for unemployment benefits.
While no one could have seen this coming, it does raise an important question: If our financial circumstances can change so dramatically, so quickly and so unpredictably, how can any of us make plans for the future? Or to put it more bluntly, what’s the point of planning if an extreme event like this can upend things at any time?
Unnerving as this period has been, and as unpredictable as the future is, here are three areas in which I think planning can be worthwhile:
Contingency Planning. Imagine you walked into the Pentagon. On the shelf somewhere, I would imagine, is a contingency plan for every conceivable type of military threat. And yet no one, not even with the resources of the Pentagon, can conceive of every possible risk. Every time something happens, it’s a little different. But nevertheless, it’s still worth planning, and here’s why: Yes, each risk is different, but they all fit into a set of categories that you can conceive of. Coming back to personal finance, these categories include:
- A disruption to your income
- A decline in the value of your investments
- Unexpected expenses
- With apologies for being morbid, death or disability
Are there other risks? Certainly. There’s hyperinflation, for example. But still, most financial problems fit into one of these four categories. And that’s the good news here. I can’t think of any financial commentator—myself included—who predicted this mess. But you didn’t need to, and you don’t need to know what the next crisis will look like. Instead, the heart of financial planning is simply to think through each of these risk categories and to have in mind a contingency plan for each.
Does this mean that you will be able to weather every storm? No, that would be naive to say. No amount of planning would have made today’s situation easy. Still, I see value in thinking about contingency plans—so you know, in advance, which levers you could pull in case of emergency.
Diversification. If you look back over the past ten years, one of the most successful investments would have been the Nasdaq 100 Index of growth stocks—Amazon, Apple, Alphabet and their peers. But if you had owned that index over the prior ten years (2000 to 2010), you would have lost money—a lot of money. Similarly, if in recent years, you had held your money in bonds, you would have lagged stocks. But this year, it’s the opposite; most bonds are doing great. This is the unfortunate reality of diversification. There’s no way to be above average all the time. But as you think about ways to protect yourself from the unknown, diversification may be your most powerful defense. And remember that diversifying your investments is just one form of diversification. There are many others. When things begin to return to normal—hopefully soon—I think it’s worthwhile to spend time brainstorming about other ways to diversify your financial life.
Insurance. Physician-blogger Jim Dahle has a book called Financial Boot Camp in which he addresses the most important topics in personal finance—everything from budgeting to student loans to investments. But where does he start? The very first chapter is about disability insurance. And chapter 2? Life insurance. In his view—and I entirely agree with him—these are the most important things. If your assets aren’t yet at the level that you can be self-insured, this should be the first thing you look into on Monday morning. While you can’t foresee every type of crisis, it is a simple mathematical calculation to know how much disability and life insurance would be sufficient in a worst case scenario.