If you turn on the news these days, all you hear are people talking about the upcoming recession. Is it coming at the end of 2019? Is it going to be in 2020? Either way, everybody seems very convinced that there is a recession coming soon. In this post, I’m going to walk you through exactly what a recession is, if it really matters and if we do have one what are the best ways for you to prepare yourself. Let’s get to it.
The reason that this recession talk has been in the news so much recently is because of what we call an inverted yield curve. What that means is when the 10-year treasury, the interest that it pays goes below what the two-year Treasury is paying. For example, if the 10-year treasury is paying 1.5% interest and the 2-year is paying 1.6% interest, that is a telltale sign that we are going to have a recession in the next 12 to 24 months or so. It also doesn’t help that it’s been 10 years since the great recession when we had our last recession. Typically, seven to eight years has been the historical average between recessions. So we’re kind of long in the tooth here. At 10 years everybody’s already feeling like there should be a recession coming, and then on top of that you have this inverted yield curve event happen and now everybody’s just talking about it. Corporate earnings are slowing down a little bit. Everybody just kind of feels like it’s time for a recession and they’re talking about it and they’re wondering how they should prepare for it.
What is a recession, and should it even matter to you if we have one? A recession is when the GDP, the gross domestic product in this country contracts, when it goes negative for six months or two consecutive quarters of negative growth is what we consider to be a recession.
GDP is the total value of everything that is produced in this country. So they measure that, and as the economy expands and we have more jobs and people’s incomes go up, the GDP expands. It goes up. So when we go into a recession, the opposite happens. We have less production in this country. Corporate earnings start to contract. Corporations might lay people off, people might lose jobs, and then we could get into situations like 2008, 2009, which was a bigger recession, “the great recession”. During that time unemployment really started to go up. A lot of people lost jobs. There was no lending going on. The economy was in very rough shape and the government had to intervene and take some big steps in order to get things back on track. So, there is a reason to be afraid of a recession, but it does depend on you and your individual circumstances.
The government and the Federal Reserve do try to step in and at least soften the blow or make these recessions not last too long. There are different levers that they could pull in order to try to help the economy get back on track. They’ve done things like the payroll tax holiday and quantitative easing, where they just pretty much flood the economy with cash. When they just print money and our debt skyrockets, and on top of that, they lower the interest rates. We just had another interest rate cut a few weeks ago where the fed lowered the rates to make money cheaper and borrowing cheaper for people to keep this economy chugging along.
Even though you have millions of people predicting the next recession and what the cause of it’s going to be and everybody has their opinion on it, the real truth is nobody knows when the next recession is going to come or what’s going to cause it. Usually, it’s something that none of us have ever heard of or even thought of that causes the recession. In 2008 2009 none of us really knew what credit default swaps were or negative amortizing loans. Those are the things that took this economy down back then, but yet nobody really knew what they were like. Yes, we could see that maybe there was a bubble in the housing market and that lending was ridiculous, that you could get a mortgage or a home equity line of credit as long as you had a pulse, you really didn’t need to have a job or any income and you could qualify for as much money as you wanted to.
There were signs at that point that something was very wrong, but nobody really knew the severity of it because we didn’t really understand the inner workings of what was going on behind the curtain. It’s going to be the same thing with the next recession. We could all say that it’s the debt in this country because the debt is 22 trillion and counting, it’s ridiculous. So yes, it could be the debt that buries us this time, but it could be the trade war, could be our relationship with other countries in this world, could be the tariffs, we don’t know what it’s going to be. Everybody has their opinion, but it could be something completely out of left field that nobody’s even thinking about. So it makes it hard to prepare cause we just don’t know what’s going to happen in the future. With all that being said, let me give you my thoughts, my ideas and some ways that he can prepare.
Eventually, a recession is coming, we don’t know when, but we go through cycles. We go through business cycles. So a recession is coming. If it’s not next year it might be the year after that. It might be five years from now. We just don’t know. A lot of people thought it was going to be three years ago, two years ago, and they started taking cash and putting it on the sidelines, waiting for the next recession. They stopped buying stocks as much or even started selling stocks, waiting for the prices to drop, and those people are still waiting. It’s a hard game to play. It’s not easy to predict when these things are going to happen. But here’s my advice for how you could prepare for the next recession when it comes.
The first thing that I really want you to focus on and understand is that your house, your situation in your home is really what matters the most. If you have very solid financials and you have cash in the bank and no debt and you are on a strong financial foundation, recession, whatever, it just isn’t that big of a deal. If anything, it will end up being an opportunity for you to add and build upon that foundation. It’s not going to be a threat to you, but another thing to understand is your job security. It’s a very different scenario if you have a couple where they’re both teachers and their jobs are very safe and secure, and even if we go into a recession, it’s not going to really impact your life very much. You’re still going to be getting paid, everything’s going to still continue and there’s not much risk to you. Compared to a married couple where one of the spouses is a stay at home parents and the other spouse is a travel agent. That’s a very risky scenario. If we go into a recession you would need to prepare much differently, but not just if we’re going to have a recession, just in general, your finances need to be dealt with in a matter. That’s much different than a family where both parents are teachers. The first thing is understanding your situation.
Now if you’re in a situation where your job might not be that secure, then this is the perfect time to really evaluate your position and look at your company and start to get a good understanding if corporate profits do go down if earnings go down, could I be laid off? Am I on that hit list? If they need to start laying people off and reducing staff, could I be laid off? Now is the time then to really start networking and talking to people that are in your industry and getting online and building relationships. Just in case you have to jump ship and you have to find somewhere else to go. That’s a good way to start planning for recession. If it’s one year from now, five years from now, whenever it is. It’s just to make sure that you have enough connections in your industry that if you need to jump ship, you could do so and land somewhere. A great quote that I recently stumbled upon said, “when you lose your job, it’s a recession, when I lose my job, it’s a depression.” I thought that was pretty funny and it’s true. If everything’s cool with your job and we go into a recession then it just isn’t going to hit home for you all that much, but if you lose your job, it’s going to hurt. You need to be prepared for whatever it’s going to throw at you.
Let’s start with some short-term ways that you could prepare for the next recession. A lot of these things, recession or not, this is just solid financial advice. The first thing is your emergency fund, your cash, you want to make sure that it’s adequate that if something happens you have enough cash on hand. You really want to focus on being a little bit cash-heavy as we get to the end of this business cycle.
One actionable item that you could do right now, which is a great idea because recessions, they do provide opportunities if you have cash, is open up a separate savings account, nickname that account recession fund and just start funneling a little bit of money in there. Maybe you make some conscious decisions in your life like if you’re going to go out to eat instead say, you know what, we’re not going to go out to eat tonight, we are going to throw that hundred bucks into our recession funds. If you could just save a little bit extra, just start padding that recession fund a little bit at a time. This way when it actually does come, you have some cash in there that you could either could tack onto your emergency funds or that you could use to take advantage of opportunities like buying stocks if they go down 30%, or buying an investment property if the real estate market takes a big beating. Don’t confuse this with your emergency fund, you still need to have your emergency fund, but just up a little side account, call it your recession fund and start throwing some money in there and build it up as much as you can. If we don’t have a recession for five years, you could get a lot of cash in that thing and you can only use it for a recession, so when the recession comes, that money is earmarked for some good investments. People get rich during recessions. That is the time to strike. One of my biggest regrets was not having a lot of money in 2008–2009 at my disposal where I could buy assets. If you bought houses back then a lot of them have more than doubled in value the same thing with many stocks. It was a great time to be buying.
That leads me into the next thing that is good to do when we think that there might be a recession coming and that is to get lines of credit available to you in place now. If you’re thinking about getting a home equity line of credit, now’s the time to do it. You don’t need to use the money, just get it available so that it’s sitting there in case life throws a curveball at you and you lose your job during a recession. You’re not going to be able to get one at that point if you don’t have a job, so put these lines of credit in place now so if disaster strikes, if something happens, you have access to them during that time. The banks aren’t going to be giving them if we go through a really bad recession, so if you have that money available to you, you could strike while the irons hot. You could buy a rental property at 50% off buy stocks at 50% off. You can start taking more risk, more chances if you have access to capital at that time.
Then the last thing that you could do in the short term is if you have any investments where you think you’re going to be using that money in the next three to five years it might be time to get more conservative. For example, if you have a child that’s going to be going to college in the next three to five years and you have their money invested very aggressively in their 529 plan, now might be a good time to dial that back. If you’re going to be needing that money in the next three to five years, you don’t want it to get wiped out. You don’t want to lose 30% if we have a stock market correction or if you have an investment property where you’re thinking, you know what, I want to sell this place within the next few years, we’re at a good time to be selling these things. Home prices are a pretty solid right now. So those are the types of thoughts that you should be thinking. If you have any investments, three to five-year time horizon, the time is pretty good right now to take some money off the table. It’s not a bad idea.
Then my last piece of advice for the short term mind-frame stuff is sit down with your significant other or if it’s just you, go through a business plan, create a one-year business plan where you have your cashflow mapped out and any major purchases that you want to have over the next year. Look at your net worth and how much money you have in the bank. Put together a plan of what your income is going to look like over the next 12 months and just have a very good understanding of what it all looks like. This way you can start to play different scenarios out in your mind if you did lose your job or if the stock market does drop 30% what effect does it have on you over the next 12–24 months? These are things you want to be thinking about when we get into this kind of cycle where we’ve had 10 years of a pretty robust economy.
All right, so now onto the long-term investments, and my advice is pretty simple here. Don’t do anything with your retirement accounts, with IRAs, or with 401ks. If you have 10, 15, 20, 25 plus years before you’re going to be touching that money then don’t even worry about it.
We’re going to go through these market cycles and you can’t let that dictate how you’re going to invest inside of these retirement accounts. The best thing you could do is just ignore the noise and continue to contribute to these accounts. Just continue with the payroll deduction, max out your IRAs every year. Just continue on that path. Hindsight is 2020, it’s very easy for me to say that I should have sold all my stocks in 2006 and 2007, but you don’t know until you get punched in the face. You just got to go with it and understand that that is going to happen. You’re going to go through cycles and that nobody can time this stuff.
A big thing that I also want to get across to you is it is not a good idea to listen to the noise and then sell your stock. If we go down 15% in the market you’re going to hear everybody saying, “Oh this is the beginning of a big recession and the stock market’s just going to go lower and lower and lower”. They might be right, it could happen, but you just don’t know. To try to time the market at that point and get out that’s one decision. The next decision is the harder one and that’s when do you get back in? As the market continues to fall you’re thinking to yourself, well I’ll just wait for it, wait for it to go a little bit lower, a little bit lower and then I’ll jump back in. But that time comes and goes in an instant. If you look at a chart for 2009 the stock market spike down and it spiked back so quickly where if you were waiting for that perfect time, it’s like you missed it and then your emotions and your mentality, they start to shift towards, well I’ll just wait for it to drop a little bit more before I buy back in.
It’s an impossible game to play. Don’t even try to play it. Especially when you’re looking at retirement money and long-term investments. You just got to go with it. You just got to continue going. The only thing you could do is once we go into that downturn, try to put more money in. Realize that it’s an opportunity and try to put more money in, but nobody’s going to time the top. Nobody’s going to time the bottom. It’s just an impossible game to play. So understand that going in and just do the best you can to be consistent and to not make any big emotional moves with this stuff. All right, everybody, that is it for recession talk.
To Becoming Great with Money,
Rich McCormack, CFP®
School of Personal Finance