Experts: 7 Ways Economic Changes Affect Financial Planning Strategies
No matter how savvy we might be in managing our finances, there’s always an element that’s out of our control: economic changes.
Like a domino effect, when the economy fluctuates, so does our money. And in turn, this means it will equally affect our financial planning.
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“When it comes to financial planning, the state of the economy pretty much sets the stage,” said Mafe Aclado, finance expert and general manager of Coupon Snake. “Because between inflation, your ability to find employment, interest rates and your ability to leverage investment opportunities, the truth is, you draw your financial plan based on how the economy is set.”
Below are some specific ways economic changes can affect financial planning strategies.
Interest Rates
Through interest rates, Aclado said economic changes affect financial planning strategies because it can either put a ceiling on the individual’s plan for upward mobility, or be the ladder that helps them scale through to the next level of success.
“Economic changes means changes in interest rates, and this can have a negative or positive effect on the individual’s ability to use credit as a tool for financial growth,” said Aclado.
Abid Salahi, finance expert and co-founder of FinlyWealth, noted the same.
Interest rate fluctuations, he explained, can dramatically alter the effectiveness of certain investment vehicles and debt management approaches.
“When interest rates rose by 2% last year, many of our clients had to pivot their investment strategies. One client, a 45-year-old software engineer, shifted 30% of his stock-heavy portfolio into bonds to capitalize on higher yields. This move increased his annual returns by 12% compared to his previous strategy,” said Salahi.
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Job Market Shifts
Job security is another important part of financial planning, said Aclado, and this aspect of a person’s financial plan, is also conditioned by the economy.
“Not just because having secure employment means having a steady flow of income, but also because your employment status is one of the factors considered by lenders when trying to determine whether or not you are creditworthy.”
Salahi similarly agreed that job market shifts play a crucial role.
“The rise of the gig economy has led to an increase in variable income streams for many individuals.”
He said this trend requires more robust emergency funds and flexible budgeting strategies.
“We now recommend our clients maintain emergency savings covering 6-9 months of expenses, up from the traditional 3-6 months.”
Inflation
According to experts, when it comes to financial planning strategies, inflation could either break you or improve your chances.
“Inflation is one of those aspects of the individual’s financial plans that is completely left to economic changes,” said Aclado. “It is very possible to be standing on the right side of inflation by setting up investments that are inflation proof.”
Being on the receiving end of “inflation bite,” is one aspect you can’t control so much, she added, as inflation raises the cost of living, cost of investment and reduces your purchasing power.
Salahi agreed that inflation is another critical factor when it comes to economic changes that can affect you.
“With the current inflation rate at 3.2%, individuals need to ensure their investments outpace this rate to maintain purchasing power.”
“We’ve seen a growing trend of clients allocating more funds to real estate investment trusts (REITs) and Treasury Inflation-Protected Securities (TIPS) as inflation hedges.”
Dayten Rynsburger, finance expert and CRO at Niche Capital CO, added that high inflation lowers purchasing power, forcing individuals to modify their saving and investing patterns.
“Thus it is important to invest in such assets that outrun inflation usually, for instance; stocks or real estate,” Rynsburger said.
Tax Policies
“Tax policy changes can significantly impact retirement planning,” said Salahi.
He noted that recent proposals to modify capital gains tax rates have prompted many high-net-worth clients to accelerate their Roth IRA conversion strategies, potentially saving them thousands in future tax liabilities.
Technological Advancements
According to Salahi, technological advancements in fintech have also transformed financial planning.
“The proliferation of robo-advisors and AI-driven financial tools has democratized access to sophisticated investment strategies.”
However, he said this also necessitates a higher level of financial literacy among individuals to effectively utilize these tools.
“These economic shifts underscore the importance of adaptable, personalized financial planning strategies. A one-size-fits-all approach is no longer viable in today’s dynamic economic environment.”
Market Fluctuations
Economic recessions or growths have an influence on investment portfolios, said Rynsburger.
“One can minimize risks through diversification and seize opportunities provided by market situations.”
Overall, he said it’s crucial to remain informed and flexible.
“Modification of various plans whenever the economic situation changes ensures the proper achievement of long-term aims financially.”
Impact On Expats
Broader economic changes can significantly impact financial planning strategies for expats and retirees, especially as these groups often face unique challenges related to currency fluctuations, inflation, and shifts in global markets.
According to Josh Katz, CPA and founder of Universal Tax Professionals, when considering the effects of economic trends, such as rising inflation or interest rate adjustments, financial strategies must be flexible and responsive to protect against risks and capitalize on opportunities.
“For expats, currency exchange rates are a critical factor. A weakening U.S. dollar, for example, could lead to higher living costs abroad if local currencies appreciate, affecting daily expenses and savings.”
He noted that retirees living off fixed incomes may need to diversify their investments to include assets in multiple currencies or stable foreign investments that can act as a hedge against such risks.
“Economic shifts in their host country, like changes in tax laws or the cost of living, can directly influence their ability to sustain their desired lifestyle.”
In times of rising inflation, which has been a significant concern globally, Katz said retirees and expats alike should consider adjusting their portfolios to include assets that historically perform well in inflationary periods, such as real estate, commodities, and inflation-protected securities.
“This helps maintain purchasing power over time, especially for those relying on fixed income sources like pensions or Social Security.”
That said, he equally noted that interest rate changes also play a crucial role.
“For retirees with substantial savings, rising rates may provide an opportunity to generate higher income from more conservative investments like bonds or CDs.”
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