The Great Recession of 2008 was a rare economic event. But recessions, which are periods of economic decline, are common throughout history — a fact that’s hard to remember given how consistently stock markets have gone up since 2008.
I write this in March of 2020. Right now, there’s a lot of turmoil in the stock market and a lot on people’s minds — from the upcoming election to plunging oil prices to the growing outbreak of coronavirus. I don’t know what we’re headed for. Nobody does. What I do know is that today, just like every day, is a good time to prepare for the future.
So in this post, I’m going to go over five different things to consider when it comes to how to prepare for a recession, how to survive during one, and how to thrive after the next one (which is inevitable) hits.
- Handling the stress.
- Revisiting your financial plan.
- Ways to save money in a recession.
- Recession-proofing your career.
- How to make more money in a recession.
Handling the Stress of a Recession
Watching your investment portfolio crater isn’t fun. And with access to up-to-the-minute pricing on your holdings — via an app in your pocket, Twitter, and 24/7 news — it’s easy to get depressed about both your investments and the state of the world in general.
The wise advice for investors, which you probably know, is to do nothing. To not touch your portfolio, and, if possible, to take advantage of the fact that stocks have gone down sharply by continuing to buy.
The problem is that our brains are not wired for this type of behavior. When we perceive danger, whether or not that danger is real, our primary focus turns to escaping it.
And while this type of behavior helped us escape immediate threats thousands of years ago — like when our ancestors had to flee a sabertooth tiger — it doesn’t serve us very well when it comes to investing wisely.
To make good decisions today, it’s important to reduce your anxiety about the future.
But don’t confuse this with an, “Oh, everything is going to be OK attitude.” The objective is to uncover what it is you can and can’t control. Then, if necessary, to take action today on what makes sense.
Identify Your Worst-Case Scenario
It may seem counterintuitive, but start by asking yourself this:
What would I do today if I lost my income, the value of my home cratered, and my portfolio dropped in half? (Or whatever your financial doomsday/worst-case scenario may look like.)
The objective here is two-fold:
- First, to identify the actual threats that exist that could negatively impact your future.
- Second, to identify what can be done to reduce the chances of your worst-case scenario from occurring.
For example, say what you fear most is losing your job, which in turn would make you miss mortgage payments and cause credit card debt to pile up.
In that case, your plan of action should be based on eliminating the chances of you losing your job, and on limiting the negative consequences if that were to happen.
So, a combination of strategies can be put in place.
These might include:
- Lowering your expenses to pay off existing debt.
- Building a side income that has the potential to replace your full-time job.
- Increasing the amount of money in your emergency fund.
- Finding a new job in a high-growth industry.
The specific options will be unique to you and your situation. But the goal is to get to a point where you start saying, “Yes, it will suck. But I can weather that storm.”
Stay off Twitter and CNBC
A recession is a great time to have a baby (imagine that market timing), get a dog, start a new fitness regimen, or launch a DIY home renovation project.
(Kidding… but not really.)
You need something to pull you away from the day-to-day “news.”
You won’t find answers or comforting thoughts on Twitter and Facebook, platforms where extreme views rise to the top.
The same goes for CNBC.
Reading Twitter feeds and Facebook comments, and watching 24/7 financial news, isn’t going to give you actionable insights.
I can’t recommend enough taking these apps off your phone. This one step can make a big difference in both your stress levels and your financial future.
Don’t mistake this for being misinformed. It’s important to know what’s going on in the world. After all, this helps you prepare for what’s ahead. It just means going direct to trusted sources like the World Health Organization, local health departments, the Economist, the New York Times and the Financial Times.
And It may be a good time to read a couple of the best investing books for beginners.
Revisiting Your Financial Plan
When times are good, it’s easy to be a bit too aggressive in your financial decision-making.
This may sound something like:
- “I only need a one month emergency fund.”
- “I need to take on more risk with my portfolio to make up for lost time.”
- “Apple, Amazon, Google, Berkshire… these companies will always earn more than an index fund portfolio, so I’ll invest in those instead.”
- “If lenders allow up to 36% of my income to go towards debt, that should be fine.”
- Or anything, really, that’s more risk than you’d like to be taking on right now.
Key Point: Financial decisions need to carry you through both good times and bad. And if you’re second guessing past decisions right now, it’s important to rethink the future.
Three core components of your financial plan that will likely benefit from a second look are:
#1. Your Emergency Fund
Is your emergency fund large enough to allow you to sleep well?
That’s the goal.
For some, this might mean three months of expenses. Others might feel better with a year’s worth of expenses. Whatever that number is, make it a goal to save enough for you to rest easy.
This is, as we often say, where you need to make personal finance personal. Rules of thumb are great, but if a 12-month emergency fund is going to prevent you from selling off your stock portfolio in favor of hiding money under your mattress, it’s worth it.
#2. Fixed Expenses (Mainly Debt)
If you’re having buyer’s remorse over a particular purchase you’re still paying for — such as your home or your car — consider cutting your losses sooner rather than later.
Debt-to-income ratios, which determine how much debt you’re able to take on, are created to maximize a lender’s bottom line — not to optimize for your financial well-being.
If you’re struggling to make payments when times are good, it’s not going to get any easier during a recession.
#3. Asset Allocation
After the Great Recession, there were lots of stories about individuals not being able to retire as their savings cratered by half or more.
The typical scenario was something like this: A couple in their 60s loses half of their retirement assets, which means they’ll need to work an extra 10 years (and maybe even longer) to ensure they have enough money to cover their living expenses.
But one of the biggest lessons of that story was overlooked; these individuals shouldn’t have had so much of their portfolios allocated to stocks in the first place, because doing so made them unnecessarily vulnerable to short-term economic shocks.
Take a look at the historical price of The Vanguard Target Retirement 2010 Fund Investor Share during the 2008 crisis:
This fund is a target retirement fund, so it’s allocated based on if someone was to retire in 2010 (e.g., someone right around the corner from retirement in 2008).
Right before the recession hit, its price was around $24. At the absolute low point, in March of 2009, it hit $15.22. By September of 2009, the value was back to $20 a share.
In an economic boom, it’s easy to want to be an aggressive investor and put everything you can in stocks. But know that if an investment declines by 50%, it takes a 100% return to make it up. (In other words, the stock’s price has to double for you to get back to break-even.)
As for 2020, year-to-date the Vanguard 2020 Target Retirement Fund is down 3.01% (as of March 11).
Again, that’s down 3.01%.
The time is now to look at your asset allocation. Does it fit your risk profile and goals?
Not sure? Check out Personal Capital’s investment checkup tool, which allows you to assess the current risk-level of your portfolio and get a target allocation based on your risk tolerance.
Ways to Save Money in a Recession
For those looking for a bright spot, recessions bring about opportunities to cut costs and save money.
The Federal Reserve tends to lower interest rates during a recession, making borrowing less expensive.
Of course, the goal isn’t to take on more debt. Instead, there’s a significant opportunity to refinance your existing debt.
#1. Your Mortgage
The recent Fed rate cut sent mortgage rates even lower than their already-historical lows.
Personally, I’m in the process of refinancing my mortgage — going from a 30 year down to a 15-year fixed. The payment increase is shockingly small and will leave me mortgage-free much sooner.
#2. Personal Debt
Beyond a mortgage, you might be able to save money by refinancing your existing personal debt. This might include refinancing credit card debt to a personal loan or refinancing a student loan.
With less money going towards interest, you’ll be able to free yourself from that debt more quickly, in turn freeing up excess cash flow that you can use to build your emergency fund or invest more during the recession.
Recession-Proof Your Career
Your career provides income, which is the gas that fuels your entire financial life. So your goals are to protect that income and then, secondarily, to identify any opportunities that a recession may bring.
#1. Improve by 1% Per Week at Your Current Job
In 2008, the unemployment rate went from 5% to 10%.
Job loss is never ideal, but on the flip side, it’s not like there were massive layoffs in every industry (even though the news covered every such instance, making the situation seem worse than it was).
The reality is that an additional one out of every 20 people were unemployed.
Taking a glass-half-full approach, you don’t need to be a top performer to keep your job in such a scenario. Being above average — e.g., in the top 50% — will provide good job security.
And while it’s easy to give the “rah rah” speech here — to urge you to work harder than you’ve ever worked before, to get there early and stay late, etc. — the truth is that the straightest path towards improving at your job is:
- Finding something that matters to measure. If you’re not sure what matters, ask your boss what the most important outcomes of your work are.
- Aiming to improve those outcomes by 1% per week.
If you’re in sales, here’s what that might look like:
- Read a book about selling or research different cold calling techniques.
- Come up with two different openings for your calls.
- Test the two different versions while you’re making sales calls the preceding week.
- Stick with the winner for the next week.
- Repeat with either another opening or by testing something new — such as the time of day you make calls, how you ask for an appointment, and so on.
Most people simply show up to work and are happy to get paid. Take a proactive approach with the aim of improving at what you’re paid to do.
March 2020 Update: A major issue ahead is the loss of many jobs that can’t be performed remotely. My hope is that we’re able to provide subsidies for people who don’t have the option to work remotely. For example, Italy suspended mortgage payments, giving homeowners such much-needed breathing room in their budgets.
On the financial side of things, this recession will be hard on many. Really hard. This is unfortunate because short-term, there are not a lot of answers. If you’ve spent years building up skills in something that doesn’t transfer well remotely, inside of an industry that’s negatively impacted, that income can’t be easily replaced.
Some state unemployment offices are putting plans in place to expedite unemployment claims. Washington State has an excellent visual for when you may be able to qualify for programs like paid sick leave, unemployment insurance, paid family medical leave, and industrial insurance (known as workers’ compensation in most states).
#2. Build Credibility and Authority
Having credibility within an industry can ensure job security and provide growth opportunities.
One of the easiest ways to establish credibility is by starting a blog. You can share what you’re learning, and any case studies or market research that relates to your field.
You’ll not only learn a lot yourself and make very important connections, but you’ll also provide proof to potential future employers that you’re serious about what you do.
#3. Diversify Your Income Sources
Making money on the side has a number of benefits:
- You’ll diversify your income sources.
- You’ll gain important skills within your field (or another complimentary field).
- You’ll build your cash cushion (or be able to invest more).
If you have a full-time job, start a business that you can build in five to 10 hours per week. A good starting point is taking on a client or two on Upwork.
What most freelancers find is that earning that first $500 to $1,000 a month is difficult. However, once you start to gain more experience, it’s easier to go from $1,000 to $2,000, and so on.
Then, if you do happen to lose your full-time job, you can always up your hours as a freelancer to get by.
Investing During a Recession
Investing isn’t meant to be a constant high. There are downs, too (and plenty of them). Expect a lot of them over the course of your life.
This fact, as I alluded to earlier, is hard to remember because it’s been so long since we’ve had a recession or a bear market. As such, there’s an entire generation of investors that haven’t dealt with a massive sting like the one we’re all feeling today.
#1. Revisit Your Asset Allocation
Priority number one is to revisit your asset allocation, which is representative of the amount of risk you’re willing to take.
Just as your emergency fund needs to carry you through good times and bad, so does your asset allocation.
Ideally, you already have a properly-balanced portfolio and are able to not get too tied emotionally up in the day-to-day swings of the market. If that’s the case, stay on your current path and you’ll be just fine.
Or, as Jack Bogle (the founder of Vanguard) said so eloquently, “Don’t do something. Just stand there.”
If you’re seriously considering doing something drastic — like moving to all cash or gold — it’s a good sign that your current portfolio needs a tweak.
Helpful resources for determining what that risk tolerance should be are:
- Use the investment checkup tool at Personal Capital to compare your current asset allocation to an optimized allocation designed to minimize risk and maximize return.
- Seek qualified, low-cost financial planning services. For example, visit an hourly CFP™ and run your plan by them.
#2. Take Less Out
If you’re no longer saving, consider withdrawing less money for a short while. Everyone else will be butting back, so it makes it a bit easier to do. Furthermore, you’ll be selling less of your portfolio at a discount, allowing it to grow more in the future.
For more information, see: How Long Will My Money Last In Retirement?
#3. Take Advantage!
In his 1997 shareholder letter, Warren Buffett wrote:
A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
For shareholders of Berkshire who do not expect to sell, the choice is even clearer. To begin with, our owners are automatically saving even if they spend every dime they personally earn: Berkshire “saves” for them by retaining all earnings, thereafter using these savings to purchase businesses and securities. Clearly, the more cheaply we make these buys, the more profitable our owners’ indirect savings program will be.
If you’re a net saver, today is where the money is made.
If your emergency fund is where you want it to be, increase your 401(k) contributions or start that Roth IRA.
You’re buying stocks at a severe discount — and thus buying more shares for the same amount of investing dollars — than last month. And that is how you can thrive once the recession starts to roll back.
How to Prepare for a Recession — Summary
Recessions are not fun. But then again, that’s why you plan for an economic downturn — so the pain doesn’t hit you quite so hard.
This is where that emergency fund comes into play, where that properly-balanced portfolio gets you through, and where your ability to make quick money allows you to sleep better at night.
Ups and downs are normal. No economy grows forever, uninterrupted and with no bumps in the road. That’s just not how markets work. But there has never been a recession or a bear market that we haven’t recovered from.
We recovered from the Great Depression. We recovered from the last recession. We’ll recover from this recession, should we fall into one. And we’ll recover from the next recession.
So stay focused on your financial goals and take a deep breath.