A buddy of mine messaged me recently asking me whether it was time to worry about his investments. Over the last couple days, the market has apparently taken a big dip – it’s got people like him worried that this might be the big correction that we’ve all been waiting for. His question was, what could he do to minimize his losses.
As most of you can guess, I told him exactly what most of us here in the financial independence community preach when it comes to investing – do nothing and stay the course. But what about all of the losses he’s already suffered!? All of the gains from 2018 have already been wiped from existence! Or at least, that’s what the media likes to tell us.
It’s one of the things I hate about financial news – this never-ending push to emphasize “losses” as if, when the market drops, people have actually lost something. The fact is, if you’re invested in a diversified portfolio (ideally low-cost index funds) and aren’t planning to tap your investments anytime soon, then market movements should mean nothing to you. The only time market movements mean anything is if those investments are actually being sold and converted into income.
For a young investor like myself, my income doesn’t come from my investments. It comes from my job. And it’s my job that pays for me to go out to eat, buy clothes, or do anything else that I want to do. My investments don’t technically do anything for me right now except sit there and make me feel good or bad.
That’s why, in times like this, I always remind myself that those numbers that I look at in my investment accounts are imaginary! They exist only on paper and they aren’t real until the moment I click sell and turn those investments into actual cash. Since I don’t plan to do that anytime soon, why would I care whether the market goes up or down today, tomorrow, next month, or next year?
Gains Or Losses Are Imaginary Until Converted To Income
When you think about it, there are really only two ways for you to finance your life:
- You can use the income you earn from your job; or
- You can use the income you earn from your investments.
The vast majority of people – especially most 20 and 30 somethings reading this – will rely on their job for their income, not their investments. It’s the actual process of going to work that gives us the money we need to finance our life. If we’re smart, we also take the money that we earn from our job and invest it – the goal here is to eventually have enough money invested so that we can use our investments to replace our job income.
Unless you’re close to that point, anything the market does now really doesn’t matter. A 50% increase or a 50% decrease doesn’t actually impact you on the investment front – it’s a number on a piece of paper. That gain or loss can only become real when you take the action of converting your investments into income. The nice thing is, you can generally make the choice about when you want to make those gains or losses real. Obviously, don’t sell at a loss if you don’t need the money now. If you wait it out, there’s a good chance (pretty much guaranteed) that your investments will be worth more in the future than they are now.
There are some caveats of course. The assumption that your investments will go up over the long term is only true if you’re invested in a diversified portfolio of index funds. If you’re investing in single stocks or other weird things (like BitCoin), then there are no guarantees. But why make life harder for yourself by doing that?
The Only Thing You Have To Worry About In A Market Downturn Is Job Loss
Even though market movements are pretty much imaginary to those of us that aren’t using our investments as actual income, that doesn’t mean that there’s nothing to think about when the next crash happens (whether that’s now or later). For those of us that earn our income from working, a job loss is an actual thing to worry about. When markets crash, jobs tend to go with it.
What this means is that you need to make sure you’re either in a position where you can keep your job during a downturn, or you have ways to continue to finance your lifestyle, even if you lose your job. When I look back at 2008, no one who was investing during that time actually lost money unless they needed to use their investment income. The issue didn’t come from their investments losing value – it came from losing their jobs. People that weren’t ready for that might have had to turn their investments into income, which meant that they actually did lose money.
Remember, your investment gains or losses only become real once you actually convert it into income. Until then, it means nothing! So put yourself in a position where you don’t have to convert investments into income during a downturn.
Take Steps To Hedge Your Income
In short, don’t worry about your investments if you’re not using it as your income source (which most of you probably aren’t). Instead, the thing to worry about is making sure that you keep income flowing in from your job during a downturn.
The good thing is that we can hedge our bets when it comes to income. Keep a nice emergency fund on hand to hold you over during the tough times. I keep my emergency fund in 5% interest savings accounts, which means that not only do I have a good cash cushion to hold me over, I also have an emergency fund that isn’t losing money each year to inflation.
Another way to hedge our bets is to have multiple streams of income. I’ve always thought it was risky to have your entire income come from only one source. Instead, do what you can to create multiple streams of income. The great thing is that we live in the easiest time ever to start a side hustle. In 2017, I earned over $16,000 from over 12 different side hustle income sources, all while working a full-time job. If something happened and I lost my job, I’m fairly confident I could figure out a way to keep some income coming in – maybe not enough to also allow me to save money, but at least enough to fund my life.
So the takeaway here. If you’re a young investor and you’re wondering about what to do with any potential market drop, the answer is to just stick to whatever plan you already had. If the market drops 50%, remember that you haven’t actually lost anything – it’s all in your head. Market gains or losses only become real when you make it real. Don’t make them real until you want to make them real.
Kevin is an attorney and the blogger behind Financial Panther, a blog about personal finance, travel hacking, and side hustling using the sharing economy. He paid off $87,000 worth of student loans in just 2.5 years by choosing not to live like a big shot lawyer.
Kevin is passionate about earning money using the sharing economy and you can see all the ways he makes extra income every month in his side hustle reports. (If you want a quick side hustle win, check out Job Spotter)
Kevin is also big on using the latest fintech apps to improve his finances. Some of Kevin's favorite fintech apps include:
- Simple. Kevin ditched his brick and mortar bank and now uses Simple as his primary checking account. Simple is totally free and, in his opinion, has the best mobile app of any bank.
- Personal Capital. One of best apps to monitor your portfolio and track your net worth. Plus, it's free to use and you get $20 for creating an account.
Feel free to send Kevin a message here.
Agreed. But what about all those people that do live off their investments in the markets. What do they do?
Or what about if they were just about to tap into their investments?
Aaron
People who live off their investments should have done proper asset allocation for their risk level up front. But if a person is approaching retirement and there is a crash, they should extend their employment or take up a new job – its the worst case for sequence of returns. Also, people not close to retirement should actually be hoping for a correction so they can put more of their money in while the market is less expensive. Best case for people is that the market is in a prolonged bear market while they are contributing and then just before they retire, it springs back to life and makes up for all the lost ground.
Great points. Agree with everything you said.
I agree with what the other commenter said – asset allocation and figuring out as many ways as possible to reduce your portfolio use to avoid the sequence of return risks. The things I mentioned, having an emergency fund and other sources of income equally apply to anyone who’s actually going to be using their portfolio soon.
We write from our own experiences, and unfortunately, I’m still too far away from actually living off my investments to have personal knowledge about what to do on that front. If your investments are income to you, then definitely folks like Our Next Life are the ones to look at. In fact, they wrote a post about that just recently here: https://ournextlife.com/2018/02/07/sequence-risk/. Definitely read that post for more info.
I agree, we need to get everyone to realise they are just paper losses, until you sell and convert them to actual real losses.
Right! It’s not a loss until you make it a loss!
Thanks for the reminder! A lot of times long-term investors like me panicked and forget that we’re here for the long haul. Human nature I guess. I think that for 2018 the stock market will still end up positive although we may be in for a roller coaster type ride. Let’s keep drinking those calming teas and relax.
I just try to remind myself this. It’s hard because I graduated during the last recession, so I know what the recession was like, but I don’t actually have any personal experience investing during a recession. I think I should have the stomach to tough it out, but can I really know? All I can do is keep reminding myself that its not real yet!
My parents are both finally fully retired. I know a market dip (or crash or correction or whatever word we are using) isn’t an ideal thing to face at the start of retirement, but they have a solid plan. I think one of the biggest mistakes that anyone can make is to view retirement as meaning that you’re still not in the market for the long haul. While they may draw down some of their investments, they will still be in the market.
This is a great post (as always!).
Hi FP, do you have any recommended books on investing? For example, Bogle?
Great question – I should probably put this in my recommendations section.
For investing, I really just recommend two books: (1) The Simple Path to Wealth by JL Collins, and (2) The Bogleheads Guide to Investing. Both books will change your life.
Thank you for your reply, Kevin! Yes, it’s a great idea to add a book list to your recommendations section! Love the FinTech apps you recommend, too!
wheres this 5% savings account? Ally is at 1.45% and consistently one of the highest i find.
They’re the Netsend and Insight accounts I write about. It’s a little hack that a lot of churners/optimizer folks like us do to maximize our savings. Basically, it’s a prepaid debit card that comes with a 5% interest savings account. Takes some work to set up, but once you set it up, it runs itself and gives you 5% interest in an FDIC insured savings account.
Thanks for sharing the article. Worth to read this article. I admit we must get everyone to understand they are only paper losses till you sell and change them to real losses. This is a great post.