Get on the Defense
Now that we’ve slogged through the Great Recession and long, slow recovery, it’s painful to imagine suffering through that again. But while economic ups and downs are bound to occur, that doesn’t mean you have to participate. By making careful preparations during more stable times, you can truly create a financial life that will be practically recession-proof.
“When guarding against the risk of a recession, the best offense is a great defense,” says Kimberly Foss, CFP, founder and president of Empyrion Wealth Management in Roseville, Calif. Building a great financial defense means protecting your cash flow associated with income and expenses, as well as protecting your savings and investments.
“As far as cash demands, our own personal ‘recession’ can occur for any one of us, aside from what is going on in the overall economy,” says Sandra Cleveland, CFP, partner at Berk Cleveland Rathmell Wealth Strategies LLC in Birmingham, Ala. “Even without a job loss, unexpected expenses can occur that throw us off balance. If you are living on the edge during normal times, you have no safety net for the challenging times.”
Here are six important steps you can take to prep your finances for any eventuality.
Build an Emergency Fund
You’ve heard this before, but to be prepared for a potential recession or simply for unexpected expenses, you should maintain an emergency fund in a bank or credit union account that is easily accessible. Cleveland recommends keeping at least three to six months’ worth of expenses in the account. Tried this before but couldn’t quite make it? Fund the account by automatic payroll deduction and you’ll never miss the money.
Expect expenses like car repairs and new tires, doctor’s bills, home repairs and upkeep, even though they are not a part of your monthly expenses, and you won’t be surprised when they do occur. If you don’t earmark these savings in an emergency fund, you'll find that the cost of these ‘emergencies’ are much greater, Cleveland says. “The costs associated with interest on a loan or charge on your credit card is in addition to the real cost of the expense. By not preparing during normal times, you are setting yourself up for more expenses than necessary during challenging times. It is difficult to recover from paying for past expenses and building up your savings and emergency funds at the same time.”
When you do use your emergency funds — only for true emergencies — replace them as soon as possible so the account will have time to build back up before you may need it again.
Create Additional Income Streams
As we learned in the last recession, no job (or paycheck) is ever guaranteed. After millions of Americans were laid off, many for extended periods of time, growing numbers of workers have developed new ways of adding income aside from their regular jobs. There are endless possibilities for creating additional income streams. You could create your own Etsy shop, rent out your garage apartment, or sell items on eBay.
Many people have started their own businesses on the side, or as full-time ventures. A business may be as simple as offering a dog-walking service for neighbors or friends, or it may be as complex as inventing and manufacturing your own super-strong dog leash (that’s what Leslie Munroe of RuffGrip Dog Leash did). The key is to think creatively, determine what skill or knowledge you have that others would pay for, and then focus on building it into a marketable concept. When you begin making extra money, use it defensively — to build your emergency fund, pay off debts or invest in mutual funds or stocks.
When a recession or personal financial hardship comes, you’ll weather the storm better if you only have to worry about day-to-day living expenses rather than paying off debts from yesterday. Work hard to pay off your debt, whether that includes credit cards, auto loans or student loans. “Don’t be misled by your peers; too many Americans live beyond their income and are spending their future income today,” Cleveland says.
If your debts are overwhelming, take an organized, deliberate approach such as the debt snowball method. If you have a lot of debt and are feeling overwhelmed, consider seeking credit counseling through groups like the National Foundation for Credit Counseling, which offers low-cost financial counseling in offices across the country.
And if you do choose to take on future debt, such as a mortgage or car loan, “make sure you are taking on debt that is reasonable for your situation,” Cleveland says. “Most lenders will offer more than is prudent for people to take on, so you have to consider your personal situation and other financial obligations.”
Stay in the Market
After experiencing steep losses in the stock market during the past several years, it may be easy to avoid equities altogether. But over time, stocks can provide the highest consistent returns of most investments. “For a recession-proof financial life, the key is not making emotional decisions that cause you to bail out of the market,” Foss says. “It's easy to get out, but when do you get back in? I coach my clients to withstand volatility and stay in the market so they have long-term wealth over time. Last year, with the S&P gaining nearly 30 percent, many clients felt great about being exposed to the stock market.”
If you have debts to pay off, though, focus on those first before making investing a top priority. “Debt costs you money,” Foss says. “So unless your investments are making more than your debt, it makes sense to pay off your debt. For example, if you have a credit card that is charging 21 percent interest, you would need to be investing the money and receiving at least 21 percent return or better in order to have an investment that is worth it.”
Foss recommends rebalancing allocations frequently, especially when profits are up. For example, “a client that typically is 50/50 equities [or stock] to fixed income [like bonds] was more like 60/40 last year,” she says. “They should take that 10 percent gain and carve it off. Put it back into fixed income. Now you've realized the gain. It doesn't go away when the market goes down.” If you are very risk averse, Foss recommends looking into an FDIC-insured CD.
Protect Your Investments
While maintaining exposure to the equities market can be important for a long-term strategy, it’s also important to protect your investments from the impact of a recession. Rather than putting all your eggs in the stock market basket, “your long-term, serious money should be invested in high-quality, low-expense mutual funds that allow you to take advantage of broad diversification that cover all asset classes,” Cleveland says.
She recommends a diverse allocation for your investments, including some stock mutual funds, which can produce a higher return but have a lot of ups and downs, and some bonds, which offer fixed income. “The bonds will not generally produce a return that keeps you ahead of inflation, but they have steady performance and are lower risk,” Cleveland explains. “By having bonds in your portfolio, it allows you to invest in the riskier stocks.”
In general, the younger you are, the greater percentage you can safely have in equities, Cleveland adds. But even if you’re already retired, she recommends maintaining a significant percentage of your investments in funds that invest in stocks so you’ll continue to have purchasing power over multiple years.
Finally, if you really want to stay ahead of financial ups and downs, you need to understand economics, investments and what’s going on in your own life and the world around you. “Don’t read about investment advice in any publication and think it’s what you need to do,” Cleveland says. “Educate yourself about the time value of money and prudent investing.”
While it can be immensely helpful to work with financial planners and other experts who are qualified and trustworthy, there’s no substitute for understanding your own situation, needs and how they fit into the larger economic picture. “The earlier you start saving and investing, the more opportunity you have to achieve financial independence at the point in life when you no longer choose to work or are unable to work,” Cleveland says.