You don’t have to be an economist to presume that that recession is most likely imminent. Even the president of the Federal Reserve bank of St Louis warned that
Unemployment may soar to 30% and GDP can crash 50% in Q2.
Some experts even say that the recession may extend into Q3. And while so many people are literally glued to their TVs and computer screens monitoring recent Covid-19 developments and stock market swings, I thought it would be good to share 10 steps you need to take now in order to enter the recession well-prepared and minimize any negative consequences on your overall financial well-being.
Before we start, let’s define the term recession. According to the National Bureau of Economic Research,
A recession is a significant decline in general economic across an entire economy lasting more than a few months and normally visible in real GDP, real income, employment, industrial productions, and whole-retail sales.
There have been 33 recessions in the United State since 1854 through 2018. The most recent recession was in 2008 during the financial crisis. Since 2008 the economy has been expanding up until now. Technically we are still in the expansion phase but as I mentioned previously most likely this is going to end soon. Although recessions are unpleasant they do happen and remain a normal part of a business cycle. Based on my experience and observations, recessions happen every 10-15 years, so they are predictable to a certain degree and give people some time to prepare. If you were caught off base, don’t get discouraged. There are some ways you can minimize your pain and even come out from the recession financially stronger.
Here’s what you need to do
- Cut your expenses. Cancel everything unnecessary – this may include subscriptions to magazines, fitness club memberships, streaming services, etc. Eat more at home, bring your own lunch to work, downgrade your internet and cable plans. You got the idea – anything that you don’t use on a consistent basis gets cut. You will be amazed how much money you can free up by cutting on unnecessary costs.
- Give a boost to your emergency fund. It’s essential to have enough cash set aside to get through periods like this. 3 months of your living expenses is a good start. If you end up losing your job or a source of income, you will not have to rely on loans or credit cards or sell other assets at cheap prices. With interest rates being near zero, make sure you to park your cash in a high-yield savings account so you can possibly earn some interest, although not big.
- Pay less in taxes by utilizing a tax-loss harvesting strategy. Recessions come with drastic market declines like the one we are witnessing now. If you check your investment portfolio you may now notice that some positions have some unrealized losses. If you have a taxable account, sell those investments at a loss and apply the capital gain loss against your capital gains or even against your ordinary income (up to $3,000 at a year). Carry the remaining loss to future years. If you decide to jump back into the same investment, don’t forget about the Wash Sale Rule.
- Reduce your debt. During hard economic times servicing debt is a back-breaking work. If you have unpaid credit card balances or other high-interest loans, make it your priority pay them off as much as possible. However, don’t tap into your emergency fund!
- Review your estate documents. Sadly, but pandemics come with death and you must protect those who rely on you and designate who will raise your kids. Make sure to refresh your will, health-care proxy, durable power of attorney, and living trust documents.
- Designate a trusted contact for your investment accounts. Terrible to say but even now, during the epidemic, there are people who exploit others. By designating a trusted contact you give your broker a permission to contact the designated person when there is evidence of fraud or financial exploitation, thus protecting your accounts from any additional damage.
- Don’t touch your workplace retirement accounts. Continue participating in your 401(k)/403(b) plan and taking advantage of the employer matching contributions (if you have such an option at work). The power of 401(k) and 403(b) plans is in consistency and regularity of contributions. With every paycheck you buy more shares during the market selloff and take market timing and guessing out of the equation. In the long run, this is strategy will benefit you tremendously.
- Rebalance your investments. Wouldn’t it be nice to buy investment low and sell high? Well, there is one way how you can do that – it is called rebalancing. Over time, the weight of each asset class in the portfolio will deviate from its target weight mainly due to market fluctuations, new contributions/withdrawals from the account, and periodically received income, like dividends or interest. This causes your portfolio to become imbalanced. For example, during down markets equities become underweight and bonds become overweight. The rebalancing process involves selling the overperforming asset class, bonds in our example, and buying underperforming asset class, equities, at a lower price. The main purpose of the rebalancing is not to increase the returns, but to decrease the risk of your portfolio – and that is why you must do it periodically.
- Buy! While it may sound crazy but if you have saved more than you need in your emergency fund, invest the rest in the market. As Baron Rothschild said “Buy when there’s blood in the streets, even if the blood is your own”. I hope we will never see real blood in the streets but the current market selloff clearly indicates that there are very good investment opportunities out there that you can’t miss.
- Stick with the plan. It is very painful to sit and watch how 25%-35% of your account balance just evaporated. You may be even tempted to sell everything in order to sit on the sidelines and wait for better times. I encourage you not to do that. As I mentioned at the beginning, recessions happen. But what’s more important is that recession go, and good times return. But guess what, you never know when good time is going to return. That is why it is essential to stick with your plan and don’t succumb to panic. In a couple of years from now you will look at the current situation with a smile on your face and give yourself a pat on the shoulder for staying the course.
As an optimist, I still hope that the recession will not come. But we all must get serious and face up to reality – the damage made to the economy by the coronavirus is big. We must be realistic that the recession is going to happen at some point of time and when it does I hope the above steps will give an idea what to do next.