- Although 2020 was a year many would like to forget, there were still important financial takeaways we'd be wise to hold on to.
- Building up an emergency fund, starting a side gig, investing responsibly for the long term and living within your means are just some of the lessons.
After experiencing a year that I am sure we would all like to forget, there are definitely some financial lessons learned from 2020 that we should use in our day to day lives going forward.
The most significant thing about experiencing events that are statistically very rare, such as a pandemic, quarantine and economic recession all happening at the same time, is that we learn how bad things can really get and how to set up ourselves to never be in that position again.
One financial lesson from 2020 is to not depend solely on just one income. Even though a job gives you financial stability, having only one source of income in today's world is, unfortunately, very unstable. Whether you have been at that job for a very long time or not, having one income is too close to having no income.
During recessions and economic downturns, it is normal and expected for unemployment numbers to rise. In April 2020, the unemployment rate rose to a peak of 14.7%, compared to the 3.5% rate in 2019.
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The wisdom of creating a "side-hustle" or e-business, or even securing a second job, is a big financial lesson from 2020. Having a second stream of income to help with expenses or, ideally, help build your emergency reserves, is great. It is also a source of income you control.
Another lesson we can take away from 2020 is to ensure that we always have at least three to six months' worth of living expenses saved as an emergency reserve.
While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income and dependents, the rule of thumb is to put away at least three to six months' worth of expenses. At least three months' worth of expenses should be readily available for bills or unexpected expenses without having to rely on credit cards or high-interest loans.
According to research, the average amount of time it takes to find a job is about nine weeks, and, of course, during tough economic times, it can take much longer to find employment.
As a result, having sufficient funds in your emergency account to support your family is a must. This will give you some flexibility to help pay bills while you seek employment.
Another lesson is to always be an investor and not a trader.
What exactly does that mean? Many people assume that once they put their money into a stock, bond, or mutual fund, it all falls under the same umbrella, which could not be further from the truth.
Most investors usually create a financial portfolio based off their life goals, age, risk tolerance, time horizon and so on. First, they take an inventory of who they are and what they are ultimately looking to accomplish from investing
Then they create a financial strategy to help decide where, when and how they would like to invest. Investors are usually buying financial instruments for the long term, whereas traders are buying for the very short term.
Traders usually buy and sell stocks based on news, headlines and technical analysis. Investors, on the other hand, usually buy and sell stocks based on their financial plan and fundamental analysis. This is often not determined by the sort of short-term stock market volatility that we saw so much of in 2020.
During 2020, the financial markets had dramatic swings of positive returns to negative returns and vice versa. Unfortunately, often too many people do not have a strategy when they invest their money into the stock market. As a result, when downturns occur, as they inevitably do, the masses often panic sell and lose money.
The S&P 500 finished with a gain of 16.26% in 2020, after hitting a low of -12% in March. During that low, many people decided to dabble in day trading. Instead of acting like investors, they sold their investments during the low and ended up losing money because of a lack of a financial plan.
Live within your means
Another big lesson learned from 2020 is living within your means. Last year actually gave people a tremendous opportunity to minimize their discretionary spending, such as eating out and going to events, because of quarantining during the pandemic. However, living within your means goes deeper than that. It basically means spending less on your lifestyle than you generate in earnings.
The first thing you need to do is keep track of what's coming in and what's going out. When it comes to shopping, for example, you need to know the difference between a want and a need.
This lesson can change your life. It may hurt at first, but learn to make daily decisions to say no to unnecessary purchases. To quote Warren Buffett: "If you buy things you do not need, soon you will have to sell things you need."
Another important financial lesson we need to understand is budgeting. Budgeting is a key to financial success.
It's hardly a new concept, but many people simply don't maintain a budget. Yet it's central to helping you achieve and maintain financial freedom.
Creating and sticking with a budget will help you avoid overspending and impulse purchases. Tracking how much money you have coming in and going out on a monthly basis is something that needs to be reviewed often.
This allows you to know how much money is left after the fixed expenses are paid. This surplus amount of money is how you get out of the continuous cycle of living paycheck to paycheck. It's how you can start to build wealth.
Hopefully, 2020 taught us more than just a few financial lessons. We all need to be better prepared for the next set of unforeseen events.
— By Jordan Awoye, managing partner at Awoye Capital