I have received many questions from clients that are wondering if they need to make changes to their financial plan in light of the recent market correction and inflation news. Some clients have been saving for a down payment and were planning to buy a home this year, but are now worried that they will not be able to afford the mortgage payment since interest rates have risen so much in the past year. In the beginning of the year, rates on a 30 year fixed rate mortgage hovered around 3%, and yesterday, the average rate on a 30 year fixed mortgage topped 6%. For a client wanting to purchase a $500,000 home with a 20% down payment this year, the principal and interest payment would have jumped from $1,686 to $2,398, an increase of just over 40%. Many clients are trying to decide if purchasing a home or continuing to rent makes the most sense, but Zumper reported today that the average 1 bedroom apartment in Chicago now rents for $1,950, an increase of 38% from last year. Purchasing a home is a hedge against inflation since you are locking in fixed housing payments, while rents can increase each year. It is important to understand how much you can afford to spend on housing, including property taxes, insurance, HOA fees, and PMI, if you are unable to come up with a 20% down payment. The amount that you thought you could afford last year is not the same as what you can afford in today' s market.
Since prices on many items have increased, it is also a good time to look at cash flow and budgeting. The usual 50/20/30 budget can get squeezed with food and housing prices going up. It is still important to save the recommended 20%, but many of my clients have mentioned cutting back on discretionary spending since they are spending more on basic living expenses. It also makes sense to look at your emergency fund to see if it is adequate in light of higher housing and food expenses. If there were a sudden loss of income, it is important to have 3 to 6 months of living expenses available so that you don't have to use high interest credit cards or sell stock while valuations are so low.
For clients considering retiring in the next year, it is important to review your budget to make sure it still makes sense. Some clients have said that they are considering working longer, or possibly cutting some items out of the budget in the short term. Clients that have already retired are wanting to look at their planned distributions and determining if they still want to withdraw at the previously determined rate since their retirement account balances have taken a hit in recent months.
Some clients have extra cash that they were planning on using for the purchase of a second home or other expense, but are considering investing in the market while valuations are low. It is also a good time to determine if Roth conversions make sense since the amount converted would be lower than last year, which would minimize taxable income.
It is also a good time to look at your asset allocation, and to make sure it is still appropriate. For long term investors with holdings that were retained only because of their low basis, it may be an opportunity to sell while prices are low, minimizing realized long term capital gains.
Since last year, the market has changed quite a bit, and it is important to work with a financial advisor who can help you make the best decisions in this changing financial environment.
About the Author
Patti Hughes is a Chicago Fee-Only Financial Planner. Lake Life Wealth Advisory Group provides comprehensive and objective financial planning, retirement planning, and investment management to help clients organize, grow and protect their assets through life’s transitions. She is a fiduciary, and does not sell products or earn commissions, so she truly acts in the best interests of her client