We’re coming up on that point in the year when most people start thinking about finances, estimating how much income you’ll earn, evaluating how your investments are performing, and how it all will impact your taxes.
It’s a great time to start preparing for the coming year.
And this year is special. In even the best of times there can be volatility in the stock market. Add to this a global pandemic and an election cycle, and many investors are concerned about ongoing volatility through year-end. We’ve already seen this play out through the year.
With this in mind, it’s important to take account of your financial strategy so you’re not caught off guard by any major swings in the market.
Here are 5 things you can do to help you prepare financially.
1. Store up cash or liquid assets
Today, many people forget that cash is a valid investment class. Cash is not only the safest asset class, in turbulent times it can also be the top performing asset class, and having access to cash in turbulent times can mean the difference of sinking or swimming. Having cash, or the ability to quickly access it, is an extremely important aspect of your investment strategy during uncertain markets.
By having some reserves set aside, you create a buffer in case your income or financial needs change.
As important as creating financial breathing room, having some cash set aside will make you more prepared to take advantage of investment opportunities that may present themselves. As a result of the ongoing economic challenges, there may be opportunities to purchase discounted or distressed assets. If you have cash available when others don’t, you’re going to be at a major advantage. As an example, think of those investors that had cash available after the 2010-11, after the crisis, and were able to purchase deeply discounted real estate in desirable areas when others were selling out of financial distress.
Another part of your investment portfolio to evaluate is your semi-liquid assets, such as lines of credit, short-duration money markets or CDs, or other assets with some measure of liquidity. Semi-liquid investments still provide some return, but are easier to access or liquidate. Moving some of your capital into semi-liquid investments can be a good strategy in addition to storing up cash, so long as you can access your money if/when you need it.
2. Refinance your mortgage and take cash out
Now this is likely a controversial topic, and may even seem counter-intuitive as part of de-risking your finances. However, with a strong housing market and historically low mortgage interest rates, this can be a great strategy to take out some of the equity in your house, while possibly keeping your monthly housing payment similar or the same.
You may be asking, “How does increasing my debt reduce my risk?” Well, it all depends on what you do with the cash you take out. If you use it to go and buy a boat or new car, that wouldn’t be very wise. But, as we just discussed in the prior point, having extra cash will provide you with reserves and an opportunity fund.
We encourage folks to get as much 3% money as they can, as long as they can put that money to work safely for more than 3%. We live in extraordinary times, and those with access to credit have unequal advantage over those who don’t, and if you do, you should make abundant use of it.
Debt is a tool of the wealthy and a key component of wealth creation if used wisely. We shouldn’t fear debt, but learn how to master it, like the wealthy do.
If you run into financial challenges and don’t have cash, sitting on a lot of equity in your house isn’t going to help you in the short run. If anything, it will only make the decision to foreclose that much easier for a bank if you have a lot of equity.
In sum, if you have cash, you’ll create a lot more peace of mind and opportunities. You can also use some of that cash to create another income stream Which leads us to…
3. Create another income stream
The oft-quoted statistic is that the average millionaire has seven streams of income. Whether or not this is the magic number, the reality is most high net worth individuals (HNWIs) have multiple streams of income.
We’ll spare you another list of “14 side hustles that take over all your free time and will earn you $1K a month.” But we do recommend creating additional sources of income.
The logic of doing this is intuitive, as having multiple sources of income creates diversification, and makes you less reliant on just one source.
Creating a new income stream can mean a lot of things, and can broadly be categorized into active and passive income. This can include anything from a side consulting business to passive investments in real estate. Most HNWIs look for something that is passive, where they don’t have to trade their time for money. Often they work with other private equity fund managers or real estate sponsors to generate this passive income, like we do with our Income Fund.
Having another source of income can help provide more margin in your budget and safe-guard you against any surprises.
4. Focus on tax-advantaged investments
This is always an important consideration for HNWIs. But especially in an election year.
Depending on how the election plays out, we may have very different tax rules come 2021. It’s a good time to not only be thinking about your investment strategy and the asset classes you think will perform well over the next several years, but to also pay attention to tax-advantaged investments. Tax rules may be changing and it’s important to be aware of those changes and take advantage of different investments that have more protection against higher taxes.
Finding investment opportunities where earnings are taxed as long-term capital gains can save you significantly on your tax bill compared to investments generating short term capital gains or ordinary income. Long-term capital gains taxes are on a graduated scale for taxable income at 0%, 15% or 20%. Much lower than short-term cap gains taxes.
Another big tax advantage to be aware of is depreciation. When your investment portfolio includes assets that depreciate, generally real estate, that depreciation can reduce your taxable income or allow you to defer income taxes into future years.
5. Consider opening a self-directed IRA
A lot of investors have been opening up self-directed IRAs (SDIRAs) to expand their investment opportunities with their qualified monies.
Most employer IRAs or IRAs at large custodians are usually limited to the investments on those platforms. By using an SDIRA, it completely opens up the opportunity set you can invest in, allowing you to self-direct your investments into options like real estate, gold, alternative assets, and private funds.
The main value of using a SDIRA to expand your investment option is diversification. You can diversify some of your risk away from the current volatility of the market, and truly invest in alternatives vs other publicly-traded investments that are all correlated together. If alternative asset classes are new to you, you may be interested in learn some benefits of alternatives.
It’s easy to put off reviewing your financial strategy, but now is a great time to take stock of your current financial situation and make a few changes. Evaluate your investment portfolio, exposure to risk, access to liquid assets, diversification and tax implications. Hopefully this has sparked some ideas for you to make changes heading into the new year.
Ben Fraser is the Managing Director and Chief Investment Office of Aspen Funds. Prior to Aspen, Mr. Fraser was a commercial lender at First Business Bank specializing in government backed loan originations (SBA & USDA), for one of the top SBA lenders in the nation. Prior to that he was a commercial credit underwriter for Crossfirst Bank, personally responsible for underwriting over $125MM in C&I and CRE loans across a variety of industries.