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The word recession is used more frequently these days. Will we be forced into a mini or longer term recession due to the coronavirus or the oil wars? Will the stock market stop bouncing around like a bobbing head doll? Can my 401K, IRA, or other investment recover after this horrific downturn? Unless you live under a rock, these are valid questions that can keep you up at night. How do you best recession proof your finances?
Traditional questions about recessions include:
What is a Recession?
It is two consecutive quarters of a fall in the domestic GDP (Gross Domestic Product). Simply stated it means the domestic economy does not grow for two quarters in a row.
Why is a Recession Bad?
Typically, unemployment increases during a recession. This makes sense since when a company makes less product, it doesn’t need as many workers. Right now there are over 20 million people in the United States that recently lost their jobs.
How Often and Why do Recessions Occur?
There have been 10 recessions since 1950, so about once per decade. Between 2010-2020, there was not a recession so some people just think we are due for a recession.
However, there is usually an underlying issue to cause the economy to go into a recession. The economy just doesn’t go into a recession for no reason.
The last recession was between 2007-2009 and was named the Great Recession. The Great Recession was linked to the subprime mortgage crisis. Most banks needed to be bailed out by the US government to survive. Unemployment was around 10%.
The unemployment rate right now is closer to 20%.
The other recent recession was in the early 2000’s (2001). This recession is frequently described as the dotcom recession. This recession also had the added issues associated with the 9/11 attacks. If you have a deep desire to read more of the history of recessions in the US, Wikipedia has a lengthy explanation.
Are We In a Recession?
Technically, the economy needs to have 2 quarters of GDP decline, so not yet. The reality is YES. The coronavirus response forced businesses to close and unemployment to spike. We are in a recession.
No one is arguing that there is a lot of volatility in the market right now. How you decide to address this volatility will determine your long-term success in the market.
There is no magic pill to perfectly recession proof your finances, but there are steps to take now. It is too easy to say “stay the course.” In fact, if you have not been addressing your risk tolerance or diversification, staying the course does not make sense.
With that said, panicking also does not make sense. My boss, during the dotcom bust, pulled all his money out the stock market. He stopped his 401K contribution. He looked smart for a couple weeks.
The problem was the market eventually went up and he was trying to time the market. He kept saying that the market would go down again. It never did. His lost opportunity cost was real.
He compounded his original loss with poor EMOTIONAL decision making.
Timing the market is a fool’s game.
5 Actionable Steps to Recession Proof Your Finances
1. Know Your Investment Time Horizon
“Money’s only something you need in case you don’t die tomorrow.” – Carl Fox (Martin Sheen) Wall Street
If history repeats itself, the market will rebound and grow over time.
The average rate of return of the S&P 500 is roughly 8% between 1957 and 2018. As mentioned above, there have been 10 recessions since 1950. The stock market does recover, but it can take time.
Your time horizon for needing your invested money will dictate your investment strategy.
If your time horizon is shorter than 10 years, make sure to rebalance your portfolio to reflect the need for limiting risk. Understanding that less risk typically results in less reward.
2. What is Your Risk Tolerance?
A dollar picked up in the road is more satisfaction to us than the 99 which we had to work for, and the money won at Faro or in the stock market snuggles into our hearts in the same way. ~Mark Twain
There are probably three reasonable responses to the recent down trend in the stock market:
- Wanting to Turtle: This response wants to sell all investments and literally go 100% into safer havens like treasury bonds and precious metals.
- Staying the Course: Understanding that markets go up and down and just ride it out. This is not a bad strategy.
- Start Speaking Like a Parrot and Squawking “Buy, Buy, Buy”: This response is from those who see opportunities everywhere and have money to spend.
A recession after a good bull market is like a party where the booze runs out. A buzz kill with a nasty hangover.
If You are a Turtle
If you want to turtle after reviewing your investments, it is time to re-evaluate your risk profile and increase the recession proof aspect of your investments. Diversification is still important, but just diversify in lower risk options.
For many people, the market has only gone up during their investing lifetime. So, this downturn has been an ugly gift.
Just because you want to turtle, doesn’t mean that you should stop investing. Just start investing where the risk profile is less. As stated above, less risk typically means less reward. During a recession, this is not a terrible play.
If You are a Parrot
Just be careful, there might still be a long way to run to the bottom. Don’t use up all your
3. Job Security and Emergency Fund
“Every day I get up and look through the Forbes list of the richest people in America. If I’m not there, I go to work.” – Robert Orben
During a recession, jobs will be lost. How secure is your job? Is it time to put more money aside to recession proof your finances? Is it time to get a side hustle?
None of this job loss talk is fun to think about but it is necessary.
If you don’t have an emergency fund, now is the time to act.
Having an emergency fund will be more important during a recession than investing in your retirement.
Keep your goals straight.
4. Debt Considerations
“If you think nobody cares if you’re alive, try missing a couple of car payments.” – Earl Wilson
Taking on considerable debt is probably not the best idea. There will be price pressures on
Additionally, do you have debt? The interest rates are low. Now is a good time to refinance.
The general rule is to consider refinancing if you can reduce your loan’s interest rate by 1%.
Another good idea is to shorten your loan timeframe.
Ultimately, the best investment during these times might be to save money on interest being paid on loans.
5. Realistic Goal Setting
The economy depends about as much on economists as the weather does on weather forecasters. ~Jean-Paul Kauffmann
The reality is no one knows for certain how long a mini or real recession will last. Recession time frames vary between recessions, so we need to set realistic goals.
During a recession, getting a 20-30% return in the stock market is not realistic. Your goals need to be more conservative and possibly resetting back to basics like increasing your emergency fund or focusing on debt reduction. Set your goals appropriately will reduce your stress.
Money stress is no joke and it impacts the majority of Americans. Setting realistic goals during turbulent financial times will help reduce stress.
There are no guarantees when it comes to the stock market. The stock market has had a nice run. It does not mean that the market won’t recover sooner than later, but there are headwinds.
Prepare yourself to meet your individual needs. If you have concerns, meet with your financial advisor. (I am not your financial advisor – see disclaimer on website).
Recap of 5 Prudent Steps to Take Include:
- Know Your Time Horizon
- Reevaluate Your On-Going Risk Tolerance
- Make Sure to Have an Emergency Fund and Plan
- Don’t Take on Massive Debt & Look to Refinance Debt
- Set Realistic Financial Goals
Achieving financial independence is highly impacted by 3 key factors – saving money, investing money and career development. The economy is stressed right now and the outcome is unclear. Take financial steps to protect yourself and recession proof your finances as best you can during these times.
Times like these are less about panicking and more about taking control of your finances. Be in control.
Below are a few good reads including a timely article on determining your financial bucket list.
Remember to Pin this article for reference.
Stay Calm and Good Luck, WhipperSnapper Finance