The US economy is experiencing expansive economic growth as the stock market hits record highs.
Does this sound like a reasonable statement for the current market situation? It’s actually a description of the Roaring Twenties that happened almost a hundred years ago. Pretty wild, eh?
In the 1920s, the Dow Jones Industrial Average, or simply the DOW, a price-weighted index of 30 leading companies listed on the United States stock exchange, rose six times from August 1921 to September 1929.
We all know what happened after the Roaring Twenties, the Great Depression, an economic abyss of restructuring and hardship for the whole country that lasted for over three and a half years.
During the Roaring Twenties, more cash chased less goods and services, resulting in asset appreciation. The stock market continued to rise and rise. Many people thought that they could make more money by investing than by working. How did this happen and what lessons can we learn from history so that it did not happen the same way it did in the 1930s?
The Roaring Twenties were a decade of prosperity and dissipation, of jazz bands, smugglers, flappers, bath gins and marathon dancers. The stock market hit new highs because investors were taking risks without understanding the risk they were taking. Many small investors believed prices would continue to rise and they wanted their share of the American dream.
When investors ran out of money to invest, they took out loans to continue their market mania, many mortgaging their homes. Most have taken out margin loans where they borrowed money to secure their current portfolio as collateral to invest more.
When there is too much risk in the market, all it takes is a significant correction to erase the gains. If you have a loan tied to a portfolio of stocks, a short-term market correction can create a domino effect by forcing investors to liquidate their stocks to make margin demands.
Does all of this sound familiar to you? If you think so, you are not alone. Here we are 100 years later, the roaring twenties of the new millennium, and we are back in a time of extreme asset appreciation. A lot of people invest in investments they don’t really understand, like bitcoin, and they think that’s their part of the American dream.
While it is easy to get drawn into the market mania, it is important to understand that this period of uninterrupted growth cannot last forever. It is important to know that there will be a market correction. A correction of up to 20% is considered part of the healthy life cycle of the investment market. However, it is important that you are prepared.
What you can do now to prepare for a market downturn.
Understand your debt. If you don’t have to go into debt to buy something, consider not doing so. Too often people get into trouble going into debt and then their cash flow changes. Suddenly, they can’t repay their loan. The banker will come and take your car, your house and your shares if they are as collateral for the loan he has granted you.
Expect to pay more. Inflation is here, and most likely everything will continue to cost more, so even if you’re happy with your last raise, you might need it to pay for insurance and basic living expenses. Keep these expenses under control so they don’t make it hard for you to pay your taxes. Benjamin Franklin once said that the two things in life that you can count on are taxes and death. This huge stimulus package must be paid off, and we will all contribute more to taxes. You probably like what your home enjoyed. Guess what, your property taxes will be too. Prepare for new, layered spending, whether through payroll deduction warrants or other new and higher federal and state taxes.
Be aware of the risk. How lucky do you have your investments? When was the last time you diversified and rebalanced? Don’t wait for a market correction to do this. Now is the perfect time to talk to your financial advisor.
Maintain some liquidity. How much money do you have ? If you were to find liquidity in a matter of days, can you convert your investments into foreign currencies without taking a big discount?
Live within your means. Don’t be tricked into thinking you need the latest iPhone when your current iPhone is doing everything you need to know. If you can’t pay cash for something, think carefully about practicing a deferred gratuity for that item.
It’s fun to see economic growth when you soar. Just remember, it’s not about whether a withdrawal will occur, it’s about when and by how much. How prepared will you be for this next turning point in our current Roaring Twenties?
Sarah Carlson is the owner and founder of Fulcrum Financial Group, of Spokane. She can be reached at 509.747.2075.