You’ve probably been seeing headlines about yet another financial crash on the horizon. It’s true, the International Monetary Fund has released grim projections for the immediate future of world finance. Why? Well, it’s complicated. Basically, the forces which were put in place to fix the last recession may just have caused another bubble in another sector.
The 2008 Recession
The last bubble and subsequent recession were caused when Wall Street took on huge amounts of cheap debt. This debt, as it was repaid, was meant to pay off many times over. But the reality of the situation was much different. In many cases, the debt was put on the back of private individuals who couldn’t handle it, who shouldn’t have been offered a loan in the first place. They defaulted en masse and — among many other factors — it caused the bubble to pop. Debt is only worth something if it gets paid back, plus interest. In 2008 the whole house of cards collapsed. Massive firms like Lehman Brothers went under and a lot of money just disappeared.
The ‘Brittle’ 2015 Global Market
Things are different this time around and Wall Street isn’t on the hook. In an attempt to stabilize global markets following the last recession, borrowing has been made extremely cheap in developed economies like the United States. Economists thought this would shock the heartbeat of the pre-Crash economy back to life, but the U.S. was never able to wean borrowers off of ultra low rates. Investors of all sizes have been snapping up this cheap debt for several years now, causing many to worry that these are exactly the same conditions that caused the 2008 crash.
There are other global factors which make this scenario different from that of 2008. This time, Wall Street isn’t the one holding all of this cheap debt. This time it’s spread all around the world, in companies, private investors and world governments. Many of the nations involved are so-called “developing” economies, which have been using cheap borrowing to fund expansion.
What Does This Mean for You?
Feel free to frolic down the personal finance blog rabbit hole to better understand what’s happening and why. But for now, let’s move our attention from the problem to what you should do if something should hit the fan.
- All the basic rules of personal finance still apply. Continue eliminating debt, budgeting, saving and investing as normal. Always have an emergency fund in a savings account, enough to cover your basic expenses for 6 months or more. If you are consider yourself low or middle class, you likely won’t be hugely vulnerable in the event of a global financial event. Stay calm, carry on.
- If you’re an investor, don’t freak out. If you have money in the stock market, this isn’t time to lose your cool. If the bottom falls out of the major markets, yes, you will lose money. But the last thing you want to do is sell out of panic when things start going south. All this does is lock in your losses. If anything, double down during a bear market. Best case scenario: The stocks you buy during a recession will increase in value a lot over the next few years. Worst case scenario (unlikely): Civilization as we know it falls apart and your money isn’t worth anything anyway.
- Don’t try to beat the markets. Invest when you have money, not according to how the market is doing. Many people lose a lot of money buying up “cheap” stocks, only to have them lose a lot more value the next day. Markets are inherently volatile. Investing regularly, regardless of what is going on, has been proven to work better over decades than only buying when the price seems right.
- Allocate your investments wisely. One great way to lock in investment values which you can’t afford to lose is to put them in stable bond markets. A good rule of thumb is to make your bond allocation percentage the same as your age (e.g., if you are 32 years old, allocate for 68 percent stocks and 32 percent bonds). Assuming a normal lifespan, you’ll have time to recover your losses in the stock market, with the assurance that your bond investments are high and dry.
- Have a nice day. If you’ve taken care of all of the above, there’s little else that you can do. If so, don’t let bad news in big finance ruin your day. You may have more complex financial needs than the ones described above, but if you don’t, try not to worry so much about the aspects of Finance which don’t directly affect you and which are beyond your control. An upcoming financial crash is by no means inevitable, even though it makes better headlines to say that it is.
As global finance continues to become more complex, there will be growing pains. Put yourself in a position to ride out the hard times that will come, and you’ll be able to get through rough patches without losing too much sleep (or net worth). Like Warren Buffett said, “Be fearful when others are greedy, and be greedy when others are fearful.”
If international finance projections continue to be hysterical and grim, stick with a plan like the one outlined here.