Recessions are a way of life when it comes to both local and global economies. The volatile nature of the stock market and other investments combined with the way world events affect economic trends means that swings between good and bad economic times are inevitable.
Like most people, you probably worry about the implications of a recession on your job and your finances. You also likely wonder what you can do to protect your family from an inevitable recession. Right now, this is more relevant than ever, as the world struggles with the economic impact of the global coronavirus pandemic.
If you already have a financial plan in place, you are ahead of the game. However, there are some additional steps you can take to help ensure that your finances can survive an economic downturn. Here are five:
Step #1: Understand How Recessions Work
Our economy has experienced recessions off and on throughout what we think of as the modern day. Following the end of World War II, the United States has experienced 12 different recessions, each triggered by a different type of event. From the Oil Embargo of the 1970s to the recent Great Recession caused by the housing crisis in 2007 and 2008, downturns have become a regular part of our financial situation.
Predicting recessions, however, can be tricky. By definition, the economic downturn that can be called a ‘recession’ must persist over a period of at least several months. Recessions are typically marked by higher unemployment numbers, a drop-off in certain types of economic activity (for instance, production and manufacturing), and a marked decrease in consumer spending. Sometimes a recovery is swift and strong, and other times a recovery is slower and weaker.
Fortunately, these negative cycles don’t last forever. Eventually, the economy will make a comeback. But in the meantime, it is important that you take steps to reassess your own personal financial situation to help weather the economic storm.
Step #2: Reassess the Allocation of Your Resources
The first step in preparing for any type of economic crisis is to assess your financial situation. If you are fortunate enough to be in a comfortable place financially before a recession, that is a big plus.
During a crisis, you will want to strike a balance with your finances between how much return you are getting on your investments, how easy it is to access your money if you need it, and how safe your funds are right now. A professional financial planner can help you strike an appropriate balance for your particular situation.
When times are good, the best way for you to prepare for a potential downturn is to shore up your emergency savings accounts. Professionals typically recommend a minimum savings amount of three to six months of your current living expenses, but that recommendation is flexible depending on your particular situation.
Consider also making a plan for maintaining insurance coverage (like health insurance), especially if your coverage depends on your place of employment. In a recession, it is always possible you may lose your job. You don’t want to be caught without a backup plan if your insurance will be lost with it.
Step #3: Consider Your Risk Tolerance
You may have heard investment professionals discuss investment allocations based on your age. The general rule is the younger you are, the more risk you can tolerate. But the truth might be different for you. If your investments are giving you anxiety, don’t suffer through the feeling just because your assets are allocated how they are ‘supposed’ to be. If you are older, and closer to retiring, you will want to reduce your risk exposures ahead of recession warnings, or as soon as you hear about a downturn coming. A professional planner or advisor is likely to be able to give you some advance warning and offer you lower risk steps to take and allocations to hold.
Do what feels right and what makes you the most comfortable. Particularly during an economic crisis, you may not want to take on more financial risk even if you are younger. The right answer is whatever makes you feel comfortable with your finances. A good financial planner will be able to help you arrive at an appropriate portfolio for your situation and preferences.
Step #4: Stay Focused on the Long Term
Even when taking your risk tolerance in consideration, try to stay focused on the long-term potential of your investments. Selling stocks at the bottom of the market often means you will lose out on significant amounts of money that could have been made if you had held on to them. The old adage of “buy low and sell high” seems obvious, but in point of fact, is actually very hard to do for most people, because their emotions tell them not to sell when prices are high, and they are very comfortable with their holdings, and not to buy when prices are low, and there is plenty of fear and confusion and pessimism. But the superior returns are made by not following the crowd-by buying assets when they are on sale and others are running away from them, and by selling into strength, when an asset is loved and demanded by the crowd. Most people need the help of an advisor on this front, as proper buy and sell disciplines are quite difficult, even over longer periods of time.
Trying to predict the market will almost always cause you trouble. The most-recommended strategy is usually to hold on to your investments, having faith that eventually the market will bounce back. Since it always does, your best bet is to focus on the long-term rather than the short-term potential of your investments. However, that “buy and hold” strategy may be inappropriate when you are in your late 50s or 60s, because if the market’s recovery takes a long time, it can alter your whole retirement outlook and time frame. For example, the S&P 500 Index reached the 1500 level in January of 2000, and did not see that level again until March of 2013—13 years and 3 months later! If a 10-15 year recovery period is too long for you to wait through, you need to use other investment vehicles that can keep your principal safe, while also keeping your money productive for you. Holding on to an unprotected portfolio can be dangerous as you approach retirement. We can have faith that the markets will always recover, but sometimes that recovery period is too long. After the great crash of 1929, it took 25 years for the markets to recover-1954! Japan’s stock market crashed in December of 1989, and it is still down 35% from its highs 31 years later! A certain portion of your accumulated assets ( usually a majority percentage for most people) needs to be safe and produce income for you for as long as you live, in retirement.
Step #5: Live within Your Means
An economic crisis is a great opportunity for you to reassess your monthly expenses. Check out your budget and where you are spending money now, looking for places you could save.
Perhaps there are monthly subscriptions you could put on hold or trivial expenses (like your daily coffee or even takeout) that could be cut down. Now is the time to tighten up your budget and live more frugally, to get through the bad cycle.