Recession? How to Prepare If the Market Pulls Back

Damian,

I keep hearing people talk about the coming recession. I know you can’t tell me when it’s going to happen, but what should I do to make sure I’m prepared for when it does happen?

– Emily

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Hi Emily,

We must be talking to the same people because it seems like I’m hearing more and more about the impending recession, almost like they’ve got it on their calendar and we’re counting down the days. You’re exactly right, no one knows if or when the next recession will start, but it can be a very uncomfortable time for many people. We’ve had a tremendously good run in the economy for a number of years, however, so it stands to reason that we’ll encounter some tougher times sooner or later.

Let’s look at a few ideas that will help you be as prepared as possible for whenever the next recession happens.

1. Emergency Fund – This is the ground level for a healthy financial life in both good and bad times. Your emergency fund will be there to provide shelter from life’s unexpected bumps and bruises, and will allow you to maintain your daily life without adding one more stress to an already difficult situation. We suggest a minimum emergency fund equal to one month’s worth of expenses. That’s the minimum. We encourage you to put away the equivalent of three months worth of expenses. You can keep it in a savings account, under your mattress, or wherever you feel like your money is safe. I’ve found that it’s a good practice to keep a small buffer between you and the money, though. In other words, the money can be accessed if you need it, but maybe not immediately. For example, maybe you consider using an online bank and savings account for your emergency fund because the money is accessible, but it will take a day or two for it to appear in your checking account to use. This small buffer can help prevent you from using your emergency fund for non-emergency purposes, if that’s something you’ve struggled with in the past.

1. Pay Off Debt – The fewer obligations/debts you have in a tough time, the more flexibility you have with your income. And, if something horrible happens (eg. you lose your job), you’ll have fewer things trying to claw money out of your emergency fund, which means it will last longer. We've discussed ways to do this a few times on the blog. Here's a good one to check out.

1. Re-Examine Your Budget – Occasionally, when things are good, we’ll make room for things in our budget that really aren’t all that necessary (I’m looking at you, Netflix). It’s not uncommon, and frankly, not really all that harmful either. As long as you’re consistently accomplishing your financial goals month to month, enjoy yourself a bit. However, if you need to free up some extra money each month because things aren’t working out quite like they had been previously, knowing where you can cut expenses ahead of time can be a huge relief. You won’t have to agonize over yet another decision when stress is running high. You’ll have already gone through the process and identified items to cut or reduce to help you get by until things normalize. Having this kind of relationship with your budget can be absolutely empowering. If you prefer to listen to learn, The Pete the Planner podcast may help!

1. Review Your Investments Now – When the markets are going well and things just seem to increase in value year after year, it’s not uncommon to put things on autopilot in our investment accounts. As the value of your investments are climbing higher and higher, that can sometimes mess up your investment allocation. In other words, maybe your mix of investments no longer matches what you’re comfortable with. If that’s the case, now is the time to get things adjusted back to where you want them to be. Maybe it’s time to reconsider the amount of risk in your portfolio, too? These are both great things to do before a down market starts.
3. Here’s what you don’t want to do: Sell everything and move into a cash position. It could be very tempting to do that, but it very rarely works out for the investor the way they envision it.
5. If you’re under the age of 50 (and don’t plan on retiring until around normal retirement age), you have very little reason to sell everything (or much of anything) and hide in cash. You have plenty of time for the market to recover prior to retirement. Plus, if you continue to invest during the downturn and recovery, you’ll be miles ahead of where you were when the recession started. You’ll be buying investments at greatly reduced prices and as they recover your account value will rise even faster because you were buying when things were cheap. Frankly, a down market is far from the worst thing to experience if you’re a young and disciplined investor. If you can keep that in mind, you’ll be fine.
7. If you’re over the age of 50, now is a fantastic time to make sure you’ve got a strategy going forward. Appropriate investment allocation? Check. Plan for what happens if things don’t recover as fast as planned? Check. Do I have an advisor to keep me honest and remind me of my goals? Check.
9. Down markets can be quite concerning at this point in your career/life, but the storm can be weathered with proper preparation.

There it is, Emily. Recessions and down markets can be uncomfortable for many and occasionally downright traumatic for some, especially if you haven’t planned. If you start preparing now, though, there’s a good chance you’ll come out okay in the end.