5 Ways to Prepare for an Impending Recession
Your finances are a blend of offense and defense. On one hand, you work hard to generate income for yourself through your job or business and put your money to work for you by investing in the market. On the flipside, it’s important to diversify your portfolio, own insurance policies and make sure your money is protected.
Unfortunately, the defensive side of your finances is easy to neglect, which can result in dire consequences. Failing to save for a financial emergency or forgetting to make portfolio adjustments over time can lead to severe financial injury, taking years to recover.
What’s more, this year’s pandemic has caused shockwaves of economic distress, handicapping many industries and causing dozens of businesses to permanently shut their doors. As the economy attempts to recover, many are concerned about the likelihood of another recession in the United States, based on the “new normal” forced upon the economy this year.
Navigating the current economy is no easy task. But you can prepare your portfolio and finances for a recession and potentially sidestep the damage.
Review your situation with a fee only financial advisory firm you can trust. Then take the following 5 steps to help prepare yourself – and your investments – for an impending recession.
1. Review Your Financial Risks
Like any disaster preparation, planning is key. Without preparation, a recession can cripple your family economically. Reviewing common financial risks can be a great way to establish a solid defense against a recession.
Get help from a fee-only fiduciary advisor who has a legal responsibility to put clients’ best interests first and help you determine real-life risks opposed to scare tactics used to sell you a specific product.
Real life risks include situations like:
- A Job Loss: Losing your job or experiencing a severe cut to your income can put an immediate strain on your finances. If a recession caused widespread layoffs in your industry and you lost your job, would you be able to live off of your savings as you find a new source of income? Would you be able to cover large expenses like private school or healthcare? If not, now is a good time to accumulate savings and devise a backup plan with your family.
- A Severe Market Decline: The Great Recession officially lasted from 2008 to 2009. During this economic downtown, the stock market lost roughly 50 percent in value, taking several months to recover while the unemployment rate skyrocketed in some cities.
Ask yourself (and your financial advisor), is your portfolio efficiently diversified? Or are you overinvested in certain asset types like U.S. stocks? Also, if the market fell significantly only years away from your retirement, how far off-track would your retirement savings be?
Once you’ve discovered certain shortfalls in your finances, you can set new goals and prepare beforehand. Work with a fee-only fiduciary advisor to create a plan for any financial what-ifs.
It’s never too early to start planning for the future. Contact Paradigm Financial Advisors and get the conversation started.
2. Pay Off Debt
Your ability to manage debt is fundamental to your financial health. If left unchecked, excessive debt – especially bad debt – can erode your monthly income and take several years to pay off completely. A recession will only exacerbate the problems caused by excessive debt.
A recession often leads to widespread job losses and significant reductions in income. Losing your job with insufficient savings to fall back on may force you to go deeper into debt, resulting in costly payments and less breathing room to cover your essentials when you need it the most.
Credit can be a useful tool in the event of an emergency, but excessive debt can damage your credit score and borrowing costs if overused. It’s wise to have a layer of savings before you start using your available debt.
3. Build Your Emergency Fund
An emergency savings is important at any stage of your financial life, serving as your primary lifeline in a financial emergency.
Ideally, try to save six to 12 months of your monthly spending in your emergency fund. Should you lose your job in a recession, you will be able to fall back on your emergency savings while finding a new position without dramatically altering your quality of life.
If several months of savings seems difficult, start with smaller, more easily attainable goals first. For example, start by setting a goal to save $1,000, and continue to build your savings from there. Automate transfers from your checking account into your savings account to make the process painless and consistent as well.
Why Six to 12 Months?
The previous three recessions lasted different lengths of time, but lingered about 11 months on average. During these previous downturns, the unemployment rate spiked and the market took a nosedive. Having sufficient emergency savings can serve as an effective buffer for your finances during a recession and can save your financial life while the economy and stock market recover.
4. Make Sure Your Risk Tolerance in Accurate
Your investment portfolio is another lifeline in your financial arsenal. If your portfolio isn’t properly managed, all of your effort to save and let your money work for you can be erased during a market correction or decline. This can occur if you fail to routinely check your portfolio, and make sure your portfolio’s risk level aligns with your risk tolerance.
Beware of Portfolio Drift
Your portfolio, and the market as a whole, is made up of thousands of different investments that don’t necessarily move in tandem. Naturally, as one investment category in your portfolio outperforms another, it’s value will outgrow your other investments, changing the composition of your portfolio. If you don’t take time to rebalance your portfolio and revert back to your originally intended mix of investments, you may drift to a new risk level in your portfolio without knowing it. Don’t assume your portfolio is on “cruise control.”
For example, U.S. technology stocks have grown more than 20 percent this year, outperforming many other stocks. If you originally created a moderately conservative portfolio, which allocates 35 percent of your portfolio to U.S. large cap stocks (the category these technology stocks fall under), this year’s market performance may cause your portfolio to drift from your 35 percent large cap stock allocation to more than 40 percent, making your portfolio more aggressive.
This market dynamic is natural, as markets are constantly changing. To remedy portfolio drift, double check your risk tolerance at least once a year (if not more), and assess if your portfolio matches the amount of risk you’re comfortable with. A fee-only fiduciary advisor can handle the heavy lifting of your investments for you.
5. Have a Long-Term Investing Perspective
Recessions can be painful for any investor. But market downturns look like only temporary blips on an investment chart in the long-run. During the worst period of the Great Recession, investors were shocked to see the market lose half its value. However, investors who utilized a long-term perspective experienced a full market recovery within two to three years, which seems like a short time in retrospect.
The longer your time horizon, the more time you have to recover after a market downturn. Maintaining a long-term investing perspective can keep you from panicking and selling your investments prematurely before markets recover.
If you’re approaching an important financial goal within the next few years – like retirement or the beginning of your child’s college years – and cannot utilize a long-term time horizon, don’t fret. Be sure that your portfolio risk level is appropriate and fits the timing of your goal. The shorter your time horizon, the lower you’ll likely want your risk to be. These are general rules of thumb. Individual circumstances may differ and we recommend that you consult a professional fee-only investment advisor to help you determine the appropriate risk tolerance for your unique situation.
How Paradigm Financial Advisors Can Help
The economy and overall market will constantly ebb and flow. History has shown us that recessions, while not an everyday occurrence, will occur. Fortunately, you can prepare your finances for a recession and avoid some – if not most – of the damage.
With the right fee-only fiduciary advisor, you can work to protect your wealth during any bull market, bear market or recession.
Paradigm Financial Advisors was one of the first fee-only fiduciary advisor firms serving business owners, professionals and families in the greater St. Louis area. We bring financial planning, investment management, estate and tax planning together to help you and your family achieve your financial goals.