New Year, New Opportunity to Plan for the Next Rainy Day

A new year ignites my obsession for Rainy Day - or emergency - funds. A couple of this week's Qs touch on this vital topic and my strong recommendation to establish one (if you don't already have one) before even focusing on saving and investing.

NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Q: I want to put my Emergency Fund in a safe place - is there anywhere to put the money besides a savings account?

A: As I often preach, you should set aside several months of income in a secure and very liquid account for emergencies. In my opinion, the least risky approach is a bank savings account because deposits have FDIC protection should the bank fail (the standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category). However, the yield on a bank savings account is virtually zero these days.

Another option is a money market account usually associated with a brokerage account with limited SIPC protection, which is not the same as protection for cash at an FDIC-insured bank. SIPC protects cash in a brokerage firm account from the sale of or for the purchase of securities. Investors often use money market accounts to store funds while deciding how to invest their “stored” dollars. These accounts allow investors to write larger checks and offer a more competitive interest rate than do banks. Alternatively, investors can access their non-retirement liquid assets for quick money, but this involves selling such assets into what could be a weak marketplace, increasing the risk of loss. My personal preference is a money market account.

Q: Would you recommend taking out a loan right now and investing the money?

A: The nature of your question suggests to me that you’re new to the investment game, and if that’s the case, my answer is no. You should be saving instead of borrowing. Why? The stock market has reached recent new highs, and there is still a good deal of unresolved chaos with regard to the coronavirus vaccination process and with a new administration coming to power. In short, there is ample uncertainty, which affects uninitiated as well as seasoned investors.

If you are a new investor, now is a good time to develop a routine savings program and to start investing on a ***dollar-cost averaging basis*** but only after you’ve covered your short-term exposure to unexpected events with an emergency or Rainy Day fund. Once you’ve established this emergency fund, start easing into the market keeping in mind the importance of diversification, quality and patience – quality and diversification initially through a broad-based index fund and patience by having the courage of your convictions.

Borrowing money to invest (in whatever) comes later… once you’ve established a good investment strategy and a track record supported by a robust and growing portfolio.

Q: I set up my 401(k) a while ago. Now, I'm being asked to rebalance my portfolio. If it's not broken, why fix it?

A: In my opinion, yes. As you seem to be doing, it’s always wise to diversify your investments… in stocks and/or mutual funds… in bonds… and in other investments such as REITs or CDs.

When markets make their inevitable “corrections” along the way, you'll be exposed to less risk because of asset allocation, hopefully providing sufficient time to recover before the money is needed. Diversification within an allocation is also important. For example, if an investor has stocks, bonds and money market accounts, but if those stocks are all in one industry, the investor still faces a greater potential for loss.

An easy way to diversify is through mutual funds, particularly index funds. Additional diversification can be gained through investment in different sized companies… large cap, mid cap and small cap… in growth and value stocks… and in different industries. For investors who prefer not to personally involve themselves in the act of rebalancing, they might consider Target-date funds-of-funds, which automatically rebalance (to a heavier allocation of bonds) as retirement approaches.

Again, there is absolutely a benefit to rebalancing, particularly as one grows older. In theory, at least, it attenuates risk during market corrections.