How to Prepare for a Recession

Right now COVID-19 is winding its way across the globe and it’s wreaking havoc with the global economy. We’ve seen factories drop production, schools are closing, and companies are suddenly adjusting to a remote workforce. The stock market doesn’t look pretty.

Let’s talk about the upcoming recession. Yes, I said it…. a recession is coming.

We’re seeing some pretty clear signs right now, but to be clear: there’s always the possibility that COVID-19 comes and goes and we still enter a recession.

That’s because recessions are part of the natural business cycle. And we are long overdue.

On average, our economy grows for about 3.2 years before heading into a “contraction” (recession) for an average of 1.5 years (source: National Bureau of Economic Research). We have enjoyed over a decade of growth since the 2008 global financial crisis. No economy can grow forever.

Statistically, we have been due for a recession since about 2013. But if you would have pulled out of the market then, you would have sat on the sidelines for a whopping 105% gain in the S&P 500 (based on 1/1/2013 - 8/30/2019).

Recently, I’ve been inundated with clients asking about what’s going to happen next. We can probably look forward to plenty of volatility in the stock market and the economy at large. So what do you during times of uncertainty?

Prepare for the Worst

Let’s talk about a few things you can do to prepare for what lies ahead.

Rebalance

Many people have been on auto-pilot for the last 10 years. Their 401k balances were going up, so they were happy. But after a 10-year bull market, if you have not rebalanced, your portfolio is most likely too aggressive.

Rebalancing means resetting what percentage of your portfolio is in stocks vs bonds (or real estate, etc.). For instance, if you were at 70% stocks and 30% bonds back in 2010, the strength of the stock market has changed those ratios. Your stock exposure may now now be closer to 90% because you haven’t been regularly rebalancing.

Check on your 401k, IRA or any other investment account you have. Find your investment allocation. Are you invested too aggressively? Now is a great time to rebalance to protect those gains.

Don’t Run Away

Here’s what you don’t want to do: pull all of your money out of the stock market. Over the course of a recession, we typically see wild swings in the stock market.

When they see the market dip, people become agitated and decide the simplest approach is to take all of their money out of the market. But hiding your money in a mattress or a savings account is more dangerous than people think.

Why? Because you are essentially selling out at a low point. You want to buy low and sell high. Selling when the market crashes does the opposite.

You’re better off waiting out volatile times than selling out of everything when you see the market tanks.

In fact, if you’re decades away from retiring, consider increasing those 401k contributions. When the stock market takes a big dive, that’s the equivalent of Wall Street having a sale. Naturally, this is only a viable option if you have the capital and the timeframe to ride out the recession. If you’re retiring next year, this is not for you.

Resist Adding More Debt

Sure, with interest rates low, it’s very tempting to buy that new house, buy a new car, or take a 0% loan for a new TV. But remember that you will have to pay that back–potentially with a lower household income. Resist the urge to take on more debt.

Strive to keep your Debt-to-Income ratio below 25%. This is calculated by taking your total monthly debt payments divided by your gross monthly income. The lower it is, the better.

Watch your credit utilization. This factor contributes to 30% of your credit score. It is calculated by taking your outstanding balances on credit cards divided by your limits. For example, if your credit card has a $10,000 limit, keep that balance below $3000.

Taking a hit on your credit score can cost you boatloads in higher interest rates for many years.

Reduce

It’s time to get cautious. Where can you spend less money? Is there travel on the horizon that you can postpone? Review your most recent credit card bill. What expenses can you cut out?

Find ways to reduce your spending and beef up that emergency fund. If you don’t have an emergency fund, now is the time to start one. Collect 3-6 months’ worth of funds in an account you can access at any time (i.e. no long term investments or CDs).

Recessions don’t last forever. This is a good time to conserve your financial resources.

Ring

Call your friends and old coworkers. This may not be the optimal time to go out to lunch with them, but email then, call them, video conference them. Get on their radar. Participate in networking events (they may now be virtual). Make the effort now so that if you need to transition away from your current career, you’ve got options.

Dust off that resume. Job loss is common in recessions. Be prepared to act quickly. If it’s been a while since you have been in the job market, things may have changed. Now is a great time to do some research on what job-hunting looks like in your industry.

Reflect

Think of the last recession. How did you make it through? Did it require big changes in your life? Could you make those changes again if you had to? Is there anything you’d do differently this time around?

Try not to get emotional when thinking about the recession. This is not easy–we are all human. The Stock Market will go down. It will also go up. It is impossible to predict these (sometimes dramatic) swings. If you are invested properly, the best thing to do is wait it out. That’s why financial advisors talk about the importance of a well-balanced portfolio.

Patience Is a Virtue

Recessions are part of a normal and healthy economy. They can be painful, and the hysteria in the news doesn’t help. Remind yourself that recessions are not anomalies, they are part of the landscape.

The average length of a recession is 17.5 months. No one knows how long the next recession will be but it won’t last forever.

The strategies we’ve discussed today are broad. If you feel like your situation is unique or you need help putting a plan into action, send me an email. With a little bit of preparation, you will be able to weather the storm.