It's been five years since the global financial crisis, and the stock market has made a remarkable recovery. The S&P 500 rose 125 percent and is now at an all-time high. The bull market has been great for many of us who kept investing through the difficult years. Financial downturns can actually be good learning experiences. If we encounter a crisis early in our investing journey, we have plenty of time to recover and learn from our mistakes.
A recent study from Fidelity found that American households have made huge strides in their personal finance habits. Many investors have taken the following steps to secure their finances further:
Save more. Investors increased their retirement contributions over the last 5 years, which means they are likely to be more prepared for retirement.
Better prepare for the unexpected. Many households have reduced their personal debt over the last few years. They also started or increased their emergency fund. Unexpected events will have less of an impact on your life if you have adequate savings to cushion the blow.
Rethink risk. Many investors sold stocks during the downturn and shifted to bonds. Of course, it's difficult to know when to get back in and a lot of people missed part of that 125 percent S&P 500 gain. Investors need to examine their risk tolerance to figure out a plan they can stick with over the long term.
Many investors lost a lot of money during the financial crisis, but the long-term lessons we learned are invaluable. There will be another financial crisis in the future, and we need to apply these lessons to avoid losing even more money next time. It's much better to go through these financial crises when you are young rather than when you are getting ready to retire.
Investing opportunities during the financial crisis. For younger investors, the financial crisis was a boon. It provided an opportunity to buy stocks at bargain basement prices. Even if your portfolio lost 50 percent of its value, it is still a small amount in the grand scheme of things when you're young. Young people didn't have a huge amount of money to lose. When you're starting out, it's more important to increase your saving rate and to learn how to invest for the long term.
It's also good to go through a big correction so you can see how the stock market recovers. You can learn from this experience and be more prepared for the next downturn. The downturn was an opportunity to figure out your risk tolerance and your target asset allocation. Many investors thought they could handle a stock market drop. However, when the S&P 500 dropped 50 percent, they really couldn't handle it. If you set your risk tolerance correctly, then you should be able to stick to your asset allocation plan and ride out the down years.
Once you have a long-term plan and a good asset allocation target, you just need to stick with it and rebalance occasionally. Of course, we all change as we get older and you will need to reassess your risk tolerance every 5 years or so. Most of us will become more conservative and our portfolio needs to reflect that.
Personal finance lessons. Even if you don't follow the stock market, a personal financial crisis can be a good learning experience. If you lose a job, you will learn to cut costs and keep some emergency funds for the future. If you lose a house to foreclosure, then you will know not to buy too much house next time. Losing a well-paying job can be difficult, but you will learn how to live a moderate lifestyle and avoid overspending. These financial setbacks can be tough, but if you have an open mind you will learn from your experience.
Joe Udo blogs at Retire By 40 where he writes about passive income, frugal living, retirement investing and the challenges of early retirement. He recently left his corporate job to be a stay at home dad and blogger and is having the time of his life.
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