With the stock market showing signs of panic, and the yield curve on the verge of inverting, the possibility of a recession is looking more and more likely for 2019. But while we can discuss the probability of a recession coming, perhaps a more important question is what to do in advance. How can someone prepare for a recession?
Much of my focus for this blog is on investments. I recommend a permanent portfolio as described by Harry Browne. I believe this is an appropriate portfolio at any time, regardless of whether we know a recession is coming or not.
In terms of investments, people would obviously prefer to be in stocks during boom times. But the problem is that we can’t predict the future. It is hard to know what will happen tomorrow or next year. Investing in the permanent portfolio is an admission that we really can’t predict what will happen, as it is dependent on millions of human beings acting.
It’s entirely possible that things could turn around. It’s possible that the Fed could make a new announcement that it is stopping the reduction in its balance sheet. Maybe stocks will return to a bull status. Nobody knows for sure.
If you really believe that we will soon hit a recession and you want to gamble, then you can obviously short the market (bet on stocks going down). Just realize that this is speculation, and you could lose much of your money if you are incorrect.
For conservative investors, it is better to stick with the permanent portfolio, or something close to it. Even for really aggressive investors, there is nothing wrong with putting half of your money in the permanent portfolio and then using the other half for speculation.
Income
Although I tend to focus on investment strategy, this is not the number one priority for most people, or at least it shouldn’t be. If you are older and have a high net worth, then your investment portfolio really is probably your number one financial priority. But for most people, the most important thing is your income.
A recession can actually be beneficial for the middle class because it helps to lower prices and reallocate resources. The problem is that the misallocated resources have to correct, and part of that process means a shifting of labor. This means unemployment or reduced work hours for some.
If your income is the most important thing to you financially – and for most people, it should be – then you should take steps to reduce the likelihood of losing significant income.
There are a number of things you can do here. If you are employed, then it is important to make yourself indispensible to your employer, or at least to be good enough that it would be painful for your employer if you left. Most companies don’t go bankrupt. It is more common to lay off a certain percentage of the employees. If you are in the top 20% of employees, then you will probably be safe.
It is also important to maintain marketable skills. If you do find yourself unemployed, you want to be able to find employment elsewhere. In a recession, a lot of people are looking for jobs, so it is harder to find one. You may have to take a pay cut. But if you have skills that are useful to employers, then it will increase your chances of finding employment.
If you have any kind of a side hustle, then it is a good idea to keep that going. Or if you don’t, perhaps you can experiment with something. You may even be able to make extra money on the side with your skills from your full-time day job. You will obviously want to make sure you are not in conflict with your main employer on this.
A final point about income is that it is good to have friends and connections. It is good to have connections anyway, but it is especially helpful when looking for work. You have a much better chance of finding employment if you have a vast network of friends. They can give you ideas. They can tell you if there are openings at their work. Or maybe they know someone else who is looking for someone dependable. You will probably have a better chance of finding work from your network of friends than from handing in your resume to random companies.
Debt and Liquidity
In preparation for a recession, monthly cash flow becomes more important. It is not just a matter of income, but also what your expenses are. I think the most important thing is to have low fixed expenses.
If you eat out a lot and spend money on entertainment, this is the easier part to adjust. It is better if you cut back before a recession hits, but at least you aren’t locked into anything. If you have to start meal planning at home instead of going out to eat, you will easily survive.
The problem for many people is that they are locked into these long-term expenses. They buy houses with a big mortgage and cars with car loans. They may have student loan debt or other debt. If a recession hits, they can’t easily cut back because these are obligations. They could default on these things, but that is what we’re trying to avoid here. If you default on your mortgage, you give up your house. And good luck defaulting on student loan debt.
Even with smaller things such as a cell phone contract or a home equity line of credit, you should be careful. You don’t want to lock yourself in for another monthly expense that is hard to escape.
In preparation for recession, you should try to pay down all debt that isn’t mortgage debt. This is good advice even if a recession isn’t coming. You want to reduce or eliminate your debt so that your monthly obligations are less.
If you don’t have any debt (other than your mortgage), then you should definitely build up an emergency fund. Some advisors will say you should have 6 months of living expenses. But if a recession hits and you are unemployed, you are going to want more than 6 months of reserves. I typically recommend 9 months, but even here I would go longer if you are worried about your employment situation.
Overall, you want to make sure that you have liquidity. In other words, you need access to money to pay your bills and unexpected expenses. This is why you shouldn’t pay extra on your mortgage unless you are set up with a good emergency fund first. It is also why you shouldn’t be pouring money into a 401k plan unless you have a good emergency fund. You can’t easily access money tied up in a mortgage (extra principal that you’ve paid) or in a retirement account (excepting a Roth IRA).
The key here is cash flow and being able to pay your bills when times are tough.
Mindset
It is hard to prepare for a recession. There aren’t a lot of things we can do to prepare other than being smart financially. All of the things mentioned above are really things that should be done whether you think a recession is coming or not.
Still, I think we shouldn’t overlook mindset. If you think a recession is coming, then at least you won’t be caught off guard when it happens. You can think a little more calmly and rationally about the situation.
If you are mentally prepared, you will also find it easier to adjust to a more frugal lifestyle. If you go out to eat a few times a week, then it won’t be as big of an adjustment for you if you have to start eating in all of the time. For someone who eats out and thinks the good times will last forever, it is a much harder adjustment.
You can’t fully know what will happen to you personally in a recession, but it helps if you are mentally prepared. Instead of looking at it from a pessimistic point of view, just understand that it is a reality that you are mentally preparing for.
It also helps to compare your situation to others in the world who have it much worse. Think of poor people living in huts on the side of the road who have to beg for food. If you have to eat cheap meals at home, then it won’t seem so bad in the big picture.
Even during the Great Depression, at least 75% of the people who wanted to work had work. People found a way to survive. If you are mentally prepared, and you take some basic financial steps to improve your situation going into a recession, then you are likely to come through it without too much going wrong.