How to weather a recession
Practical personal financial and investment strategies
Recessions are generally defined by economists as two consecutive quarters of declining gross domestic product. Put that way, it sounds dry and academic and with no real impact on the real world. In truth, recessions can be hugely disruptive, including business shutdowns, job loss, bankruptcy, and general personal financial misery.
With interest rates rising steadily as central banks attempt to bring roaring inflation under control, stock markets have gone into a tailspin, and major U.S. stock indexes are now in bear markets (down at least 20% from recent highs). A persistent, steep market selloff like this has historically preceded an economic recession.
So what can you do to recession-proof your personal finances ahead of a serious economic downturn?
1. Build an emergency fund
“In a recession, cash is king.” It may be a cliché, but that doesn’t make it any less true. One thing that characterizes recessions is uncertainty. This is why it’s essential to have three to six months in an emergency fund for life’s unexpected expenses.
Remember to pay yourself first. Consider personal savings as the first bill you must pay each month. If you haven’t been able to save because you have debts to pay, make minimum payments on all your debts and use any money left over to build your emergency fund.
Generally, you should have enough to cover at least three to six months’ worth of essential living expenses. This boils down to a little budgeting. And it doesn’t take long.
Once you’ve established what you need to cover your time period, start your fund using these these key principles:
- Set a regular savings goal. Whether it’s $15, $25 or $75 a week, stick with it. A goal is a great motivator.
- Be consistent. Set aside that specific amount each payday. Use an automatic transfer plan. offered by most financial institutions, to move your contribution from chequing to savings.
- Monitor your progress. As positive reinforcement, check your account statement monthly.
- Increase contributions when you can. As your cash-flow changes, maintain your contribution at the same percentage, thus increasing your regular contribution amount. This will help you build you emergency fund even faster.
- Use one-time opportunities, such as tax refunds, bonuses, or gifts to top up your emergency fund.
2. Practice smart investment management
The big stock market indexes have been on a steep slide since the beginning of the year. Anyone with a passive, “buy-and-hold” type of equity portfolio will know the discomfort this can cause as each day brings another shrinkage in value. So what can investors do?
First of all, you will want to put your portfolio allocations under a microscrope and rebalance methodically as necessary. Here are the key components:
Asset allocation. The dispersion of your funds among the three key asset groups of safety, income, and growth define the risk that you are willing to accept for the return you expect. When that allocation is skewed by a bearish cycle, your risk profile may have changed as a result. So bring your asset allocation back into line with your risk profile, say, by increasing your cash allocation to cushion agains further erosion in equity and fixed-income valuations. An enhanced cash allocation will also position you to take advantage of oversold market conditions.
Diversification. Is your portfolio sufficiently diversified in each main asset class? Diversification is at the heart of best practices portfolio planning. It makes no sense at all from a risk-mitigation perspective to have your portfolio allocated 50% to fixed income and 50% to equities, and then have only one bond and one stock in each class. Review your portfolio to ensure individual asset classes contain sufficiently diversified individual securities.
Security selection. When researched, analyzed, and selected properly, individual stocks and bonds within a portfolio work in harmony to achieve a specific purpose, say a minimum dividend yield or a specific target price gain or a specified yield to maturity. Hasty or ill-advised trading in reaction to unfavourable market conditions can throw that plan right out the window.
Rebalancing should be a tentative, methodical, and gradual. Work with your advisor to determine the best sectors and industries to explore as possible recovery candidates. For example, in the current environment, growth sectors like information technology have seen the biggest repricing as investors become more cautious and shift to value stocks and defensive sectors.
3. Pay off debt
Recessions often lead to layoffs and make it harder to find work. So, it’s essential to streamline your cash flow and focus on paying off non-mortgage debt as soon as possible. It will also help reduce stress during the challenging times ahead. There are two well-known methods for paying off debt:
- The avalanche method. Start paying off the debt with the highest interest rate (e.g., credit cards) as fast as you can, while you make minimum payments on the other debts.
- The snowball method. Organize your debts from the smallest to the largest amount. Pay the smallest debt amount (regardless of the interest rate attached) as quickly as you can. Make minimum payments on the other accounts to avoid late fees.
4. Live within your means
In an era of low interest rates and full employment, it’s easy to splurge. After all, you’ll just pay it off tomorrow, won’t you? A recession turns that hypothesis on its head. You won’t be able to spurge, and you won’t be able to pay it off tomorrow. To ward off financial disaster, it’s time to buckle down and create a budget to survive a recession.
First, get a handle on your income, expenses, and savings. Determine how much income you have. If you receive pay from an employer, use the “net” amount, that is after taxes and withholding. If self-employed or have variable income as a gig worker, use the net income for the lowest-earning month over the past year to give you a margin of safety.
Next, pin down your monthly expenses, divided into “fixed” (e.g., mortgage, loan payments, lease, utilities, etc.) and “variable” categories (e.g., groceries, entertainment, clothing, etc.).
Totalling your monthly income and expenses in two columns, you’ll see very quickly where you stand. If you have money left over at the end of the month, consider adopting the “50-30-20” budget plan. This plan allocates 50% of your budget to “needs,” another 30% to “wants,” and the remaining 20% to savings. But if your monthly income runs out before your expenses do, try trimming variable expenses first, and then work on reducing fixed expenses.
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at firstname.lastname@example.org for a confidential planning consultation.
Notes and Disclaimer
Content copyright © 2022 by Robyn K. Thompson. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.
The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.