The article “Five Key Personal Finance Lessons We Should Be Learning From This Crisis” was originally published on Financial Post on July 21, 2020.
The pandemic has put the financial plans of Canadians to the test and also reminded us why we make such plans to begin with
The first half of 2020 has been extraordinary on many levels and there is still significant uncertainty about what lies ahead.
While the pandemic has put the financial plans of Canadians to the test, it has also been the kind of crisis that reminds us why we make such plans to begin with.
With that in mind, here’s a look at five key lessons that have been reinforced by the pandemic and that can still help Canadians navigate the unknowns to come.
Stocks can be volatile
The S&P/TSX Composite was down 21 per cent in the first quarter of 2020. One of the biggest risks for a long-term stock market investor is abandoning a sound investment strategy by panic-selling after a stock market downturn and making a temporary loss a permanent one. I wrote about this in mid-March during the week the TSX hit its low point for the year.
Individual stocks can certainly lose all their value and go bankrupt. However, the whole stock market cannot go bankrupt. A diversified, balanced portfolio will lose money about one out of four years but will generally trend upwards over time and is highly unlikely to have a negative return over a five-year period.
After a significant stock market decline, the odds of stocks rising generally increase. 2020 has been no exception. The TSX was up 17 per cent in the second quarter ending June 30 and is currently up over 40 per cent from the March lows and close to breakeven for the year.
When you invest in stocks, you must expect to lose money in a given day, month, year, and occasionally over a multi-year period. Stock market investing is kind of like physical fitness, though. If you lift weights enough days in a row, you will build muscle. If you walk around the block enough times, you will burn more calories. When you invest in stocks, if you do it long enough, you will see results.
Debt is dangerous
The Bank of Canada had an interest rate announcement recently and left rates unchanged. Financial projections in their Monetary Policy Report suggest the economy may not be back at full capacity for three years, and as a result, interest rates may not rise until 2023.
In fact, new Bank of Canada Governor Tiff Macklem was unusually clear with Canadians that “if you’ve got a mortgage, or if you’re considering to make a major purchase, or you’re a business and you’re considering making an investment, you can be confident that interest rates will be low for a long time.”
The Bank has decreased the prime rate by 1.5 per cent so far in response to COVID-19 and as a result, borrowing costs for mortgages have followed suit, with five-year fixed and variable mortgage rates both plunging below two per cent. Borrowers who took out mortgages in 2018 in particular may find themselves in an interesting position. Five-year fixed rates were well over three per cent for most of that year. Home equity lines of credit may have rates between 2.45 and 2.95 per cent right now. Borrowers who are a couple years into their mortgage term may be able to use their line of credit to make lump-sum prepayments of 10 to 20 per cent of their original mortgage principle without penalty. Their debt would immediately be at a lower interest rate with interest-only payments. The line of credit debt could then be converted to a regular fixed payment of principal and interest at rates of around two per cent. Some borrowers may be able to save hundreds of dollars per month in interest charges.
Low rates are good for borrowers in the short term, but in the long term, taking on too much debt can limit one’s ability to save for other goals like retirement. So, while the Bank’s intention behind lower rates is to encourage spending and inflation, be careful not to let your own spending and debt derail your financial plan.
Emergency funds have a purpose
Banks have provided payment deferrals for mortgages and other debts in response to the pandemic lockdown. The federal government came to the rescue with the $500 weekly Canada Emergency Response Benefit (CERB). Had they not, many Canadians may have had a tough time staying afloat.
Recession-proof professionals such as dentists saw their incomes stop overnight, not to mention the millions of other Canadians who have become unemployed or underemployed due to COVID-19.
Anyone who did not have an emergency fund before would be wise to try to build one going forward. An emergency fund can be a savings account, but other options include a Tax Free Savings Account (TFSA) or home equity line of credit. One problem with using a TFSA as an emergency fund is if the investments are aggressive and exposed to stocks, there is a risk that when the funds are needed, stocks could be down.
Don’t lose sight of spending
Consumer spending declined significantly in the initial weeks following lockdown. It is tough to spend money when you are confined to your home. One key lesson some of us may have learned is how blurred the line between basic necessities and discretionary spending has become.
Workers who were lucky enough to maintain their incomes during lockdown likely saw their expenses decline and savings rate increase. In fact, Statistics Canada reported the household savings rate hit 6.1 per cent in the first quarter of 2020 — the highest level in almost 20 years.
One of the challenges savers may experience is lifestyle creep. As our incomes rise, spending tends to follow suit. The result may be a never-ending cycle of limited saving capacity. So, now may be as good a time as any to set up a regular savings plan to invest money monthly while spending may still be lower than normal. If saving happens automatically, and is budgeted, you may not even notice the missing money.
Prepare for the worst
Many people know someone who has contracted COVID-19. Some have been relatively unscathed, while others have become quite sick. Some have died. This is a good reminder that everyone, even young, healthy people should plan for the risk of disability or death.
The best way to mitigate against these risks, at least financially, is with insurance. Any working age Canadian who is not financially independent should have disability insurance to replace their income if they cannot work. Disability insurance pays a monthly benefit to a disabled recipient.
Anyone with financial dependents should also have life insurance. Life insurance pays out a lump sum benefit to replace someone’s future income for their family.
Everyone, even young, healthy people should plan for the risk of disability or death
Basic group insurance plans may not provide sufficient coverage for an employee. Optional or third-party coverage may be necessary to be adequately insured.
Wills, powers of attorney, and similar estate documents should be a consideration for any adult, even if they do not have dependents.
Doom and gloom aside, COVID-19 may have taught some of us about the importance of living for today as well. Life is short. I have witnessed first-hand, both personally and professionally, those who have saved diligently for a long retirement that they will never enjoy. So, while saving and delayed gratification are certainly important, this may be a good time to re-establish a balance between saving for a rainy day and living for today.
As Morris West once wrote, “If you spend your whole life waiting for the storm, you’ll never enjoy the sunshine.”
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.