You have likely been thinking about the recession that may be coming, and what you need to be doing to protect yourself from a recession.
What is a recession?
First, let’s define what a recession is. A recession is defined as two consecutive quarters where Gross Domestic Product (GDP) declines. There are other factors that are normally associated with a recession like rising unemployment, declining personal income, declining home sales, and plenty of other indicators. But GDP is the easiest one to keep track of to let you know that you’re “officially” in a recession. While we have not yet had two quarters of declining GDP yet, it’s pretty clear that we will soon be there. The only problem with following the GDP indicator is that by the time you’ve had 2 consecutive quarters of decline, you’re well into the recession, and possibly near the end of it.
One signal that commonly precedes a recession is an inverted yield curve, when short term interest rates go higher than longer term interest rates. This happened here in the US most recently in March of 2019. While this is not a guarantee of a looming recession, maybe it’s more of a self-fulfilling prophecy.
One reason yield curve inversions happen is because investors are selling stocks and shifting their money to bonds. They’ve lost confidence in the economy and believe the meager returns that bonds promise might be better than potential losses they could incur by holding stocks into a recession. So demand for bonds goes up and the yields they pay go down.
This widespread loss of confidence explains why inverted yield curves have proceeded every recession since 1956.
A Credit Suisse analysis shows recessions follow inverted yield curves by an average of about 22 months. This is of course an average, and we have never before seen a situation like the one we’re in where the entire world economy has been shut down because of this Coronavirus pandemic.
How to protect yourself from a recession.
- Have a good cash position. In a recession, jobs are disappearing across the board. Having an emergency fund is critical. Having cash to pay your monthly bills, buy food, and take care of other emergencies is the first step in a financial plan. Ideally you want to have 6 months’ expenses saved up. Where should you put this money? Keeping your emergency savings in a safe place seems too obvious to state. Savings accounts, money markets, or short-term CD’s are all a great choice. You should also keep a certain amount of it on hand at home, just in case you’re not able to use electronic means to access your cash for whatever reason.
- Reduce discretionary spending. This is the time to tighten up the budget and to defer big ticket items. Backing off on your spending is not what will help the recession end sooner, but it’s what you need to do to protect your family. You just don’t know if the recession will last for 6 months, or for two years or more. If you absolutely have to make a big ticket purchase, consider second-hand, pre-owned or refurbished options to save money.
- Make sure your job/income source is stable. As companies start to cut jobs, you definitely want to make yourself more valuable at work. Bring your A-game every day. If your boss has to decide which 20% of his employees have to go, make sure you’re not on the top of the let go list. Taking on more responsibilities is one way to do this. Also, don’t be in a hurry to change jobs. Only the most financially sound companies will keep their heads above water, and even those will have to reduce head count. Newer employees are often the first to be let go. You could also start looking for additional ways to make more money such as a freelance gig or working overtime.
- Ensure your medical coverage. We all know how high medical costs have gotten. A recession is not the time to have a big medical bill hit you. If you do happen to lose your job you’ll have to decide between keeping your old employer provided plan through COBRA, or buying your own coverage through healthcare.gov.
- Debt strategies. If you do get into a bad cash flow position, you may have to negotiate with creditors to keep them at bay. Leverage your good payment history to get concessions like postponing or deferring payments. Approach your lenders proactively with justifiable reasons for rescheduling your payments before they start taking action.
- Continue your periodic investment plan. Regular periodic investing (dollar cost averaging) during a down market helps you buy more shares at lower prices and reduces your overall average cost. A few years from now when the market has recovered, you’ll be glad you kept buying throughout the downturn. Of course, this only applies if you’re able to keep your job and have excess funds to invest.
- Make your portfolio less volatile. During a recession the stock market typically doesn’t perform well at all. But it is very difficult and very dangerous to try and time the market by trying to sell your stocks to avoid it. A better strategy is to shift your portfolio into more stable holdings that have a better chance of surviving the downturn. Consumer staples, utilities, healthcare are good choices. It’s also a good idea to limit your exposure to small and medium sized companies, and stick with larger more stable companies. Think high quality in both equities and fixed income. Bonds have risk just like stocks do. Bonds are given financial strength ratings that tell you how secure the company is. If the company fails, you can lose all your money that was invested in those bonds (Lehman Brothers bonds went to zero when they filed for bankruptcy). Other safe places to park money would be fixed annuities or fixed index annuities.
- Add some gold to your portfolio. Gold prices can be unpredictable as they are driven by a combination of supply, demand, and investor behavior. In real terms, gold prices topped out in 1980, when the price of the metal hit nearly $2,000 per ounce (in 2014 dollars). Anyone who bought gold then has been losing money since. On the other hand, the investors who bought it in 1983 or 2005 would be happy selling now. As economic conditions worsen, the price will (usually) rise. Gold is a commodity that isn’t tied to anything else; in small doses, it makes a good diversifying element for a portfolio.
- Avoid real estate. The housing market is directly tied to the economy and jobs market. An economic slowdown will impact home prices and real estate, although it may be slower to react. If you’re buying a home to live in, then go ahead and buy it. But if you’re looking for a second home or an investment property, it may be best to wait for prices to bottom out.
You may not be able to do ALL of these things, depending on your situation. My advice would be to do the best you can, with the resources you have available to you. If you’d like to talk about your personal situation and get some help, call us or schedule an appointment today.