This month marks the 10th anniversary of Lehman Brothers’ bankruptcy, a collapse synonymous with the 2008 financial crisis. The U.S. emerged from the Great Recession in 2009, entering what may be one of the country’s longest periods of economic expansion.
But if all good things must end, it’s natural to wonder when to expect the next downturn and how to prepare. There’s chatter that a recession is on the horizon, and while no one knows exactly when, some economists think the U.S. economy could enter a downturn in 2020. The Federal Reserve also signals that gross domestic product — the value of all goods and services produced across the economy — will slump in 2020. Echoing fellow economists, Tendayi Kapfidze, chief economist at LendingTree, MagnifyMoney’s parent company, said he expected the economy to slow the second half of 2019.
“This does not mean it will go into recession though,” he noted, “although the risks are higher when underlying growth is slower.”
When the economy takes a turn for the worse, it could put your financial goals, as well as your job, in jeopardy. It’s time to take a look at your overall financial picture — investment, savings and debt — to make sure you will be in a strong position to ride out any potential economic storms.
MagnifyMoney surveyed nearly a dozen certified financial planners to help you prepare for the next recession, financially and mentally. They shared four pieces of advice to reduce risks.
Take a look at your 401(k)
When it comes to preparation, the No.1 rule is to not let a looming recession dictate your financial decisions. In other words, don’t try to time the market. However, you can prepare for a recession by having good investing habits — having a strategy and sticking with it.
“The best thing people can do now is just verify that that their portfolio is appropriate for them,” said Angela Dorsey, a certified financial planner based in Torrance, Calif. “If it’s too risky, you should make changes now and not wait for the recession.”
Do nothing if you have the right investment mix
Over the past few years, many people have aggressively invested in equities as the stock market has been on a roll. Now, it’s time to ask yourself: “How would I feel if the market goes down 20% in a year?”
Be honest with yourself: if you think you can tolerate the potential loss, have an investment strategy and the discipline to stick to your plan when the market goes down, stay on course. Do so especially if you are young, when time is on your side and you can afford to have a stock-heavy portfolio.
“You just stick with your 401(k) contributions, stick with your portfolio,” Dorsey said, using an example of a 30-year-old investor. “Because she’s young and she’s got all these years right out of the recession and be prepared for the next bull market.”
That said, Dorsey recommended you rebalance your portfolio if it strays from your strategic allocation — a balanced mix of stocks, bonds and other securities — no matter how old you are and which economic cycle you are in.
Basically, your portfolio should be appropriate for your risk tolerance. If your plan is to have 70% of your investment in stocks and 30% in bonds, but the market has gone up, a greater percentage of your overall wealth may now be in stocks. What you should do now is verify that allocation and make sure your portfolio is still balanced 70-30.
Reallocate your assets if you are worried
However, if you are nervous about an economic downturn and think some loss in your retirement savings will keep you up at night, or you may act emotionally, the time to rebalance your assets is now.
“When you’re not emotional about it, when it’s not free falling like it did in 2008 or in 2001, 2002, you can make some adjustments,” said Scott Bishop, a certified financial planner in Houston, Texas. “Because you can see if there’s some flaws in your portfolio that might be subject to market risk by lack of diversification.”
You need a strategy in your portfolio that keeps you invested but may reduce the risk.
1. Balance more assets toward fixed-income securities
Depending on your risk tolerance and whether you have other sources of income, when you’re gearing toward a more conservative portfolio, you need to bulk up on less risky, fixed-income instruments. Fixed-income securities include bonds, money market accounts and CDs within or outside of your retirement plans.
This holds especially true for those approaching retirement but still holding an aggressive portfolio — you don’t want the money you need in retirement to take a hit right before you retire. If you have a bigger portion of your portfolio in bonds, fixed income or cash, you could pull money from that fixed-income piece during a recession.
“The last thing you want is to have a major part of your portfolio in the stock market, and when it goes down, it takes a big hit,” Dorsey said.
2. Invest in an earlier target-date fund
Another strategy to protect your savings from a huge loss: moving your core savings — the money already invested — into a target-date fund that’s earlier than your expected retirement date. If you are young but it’s bothering you to see your $10,000 401(k) savings turn into $1,000, this method can also apply to you.
The investment mix in a target-date fund will change over time, transitioning into more conservative assets as you get closer to retirement. The sooner the date of the fund, the more conservative the allocation is.
Let’s say you are going to retire in 2040, but you are already concerned about the market. Take your invested 401(k) money and maybe put it in a more conservative allocation — a 2025 or 2030 target-date fund.
“That allocation protects you more against the downside,” Bishop said. “If the S&P 500 goes down by 20%, maybe you’d be down by 10% or 12%, something very recoverable but also not so low-interest that if the market goes up for another year, you’re not going to completely miss out.”
3. Invest new monthly contributions aggressively
Whether you manually allocate your assets or move a lump-sum principal to a target-date fund, keep contributing to your 401(k) but invest the new money aggressively in stocks, so that in the long run you will build the equity back up in your contributions.
“If the market does go down, would you like to have your new money buy cheaper stocks?” Bishop said. “Unless their plan balance is already huge given their age, like they already have $1 million, it’s OK to have a level of volatility.”
Don’t act on fear
One common pattern that financial planners have seen is that people take action because of emotion.
“When they are emotional, they tend to buy on greed when the market’s going high and sell on fear when the market’s going down,” Bishop said. “If you’re buying high and selling low, you’re doing exactly the opposite of what you need to do to make money in the market.”
A recession is completely normal. With your retirement savings, you’ll need to keep a long-term perspective, because another bull market will arrive.
The bottom line: Do not panic when the next recession hits or allow your emotions to get in the way. Take a deep breath and start preparing for it now by looking at your asset allocation and rebalance your investments if needed.
“Don’t sell,” Dorsey said. “Selling is the worst thing you can do.”
Reduce your credit card debt
As a recession looms, one way to protect yourself is to pay down your high-interest debt. This is to make sure that you will have enough liquidity when a recession hits.
“That’s the best risk management tool,” said Dennis Nolte, a certified financial planner in Winter Park, Fla. “With interest rates going up, anybody that’s got revolving debt realizes that their interest rates on their debt are going up. If you get a 20% credit card, start paying that down, first and foremost.”
Build your emergency fund
Another way to strengthen your foundation is to be sure your emergency fund is cash-flush.
For those who don’t have an emergency fund, it’s the perfect time to start saving three to six months of your spending in an emergency account — you don’t want to be forced to pull money out of the stock market during a correction for any unexpected event, such as a job loss.
Some people prefer to save their emergency funds in a plain vanilla savings account with a brick-and-mortar bank. As the Federal Reserve continues to raise interest rates, interest rates of online savings accounts, money market accounts and short-term CDs have swung up, as have short-term Treasury bond yields. If you stash a portion of your rainy day cash in one of these shorter-than-one-year guaranteed-income accounts, or buy short-term Treasury bonds, you can have something liquid but also will get a reasonable return.
If you’re young, more adventurous and financially-secure, Nolte suggested you invest part of your emergency money in a Roth IRA, rather than shovelling every penny of your emergency fund in a plain savings account for an emergency that may never happen. You can take your contributions out anytime without any tax penalties, leaving the interest in the account.
Set aside cash for short-term needs
If you have money invested in the market for short-term goals, be it getting your roof repaired or buying a car or a house in the next few years, it’s time to take those funds out. That money needs to be set aside in an interest-bearing account, so it won’t be influenced by the market.
“[This] should be the case anyway, but over the last few years people have gotten a little too ambitious and say, ‘Oh gosh, I want to buy a house in five years so let’s be super aggressive and put it all in stock so it can grow.’” Dorsey said. “They can grow but they can also go down.”
The bottom line
No one likes a recession, but all economic cycles have their peaks and their troughs. Avoid letting a recession dictate your financial goals and decisions. Don’t make drastic changes to your stock portfolio based on fear. You can prepare for the recession now by revisiting your 401(k) portfolio and making sure you have a balanced mix appropriate for your own risk tolerance. When the next downturn occurs, remember that another expansion will eventually arrive. As for reducing debt, establishing an emergency fund and setting aside cash for short-term needs, these are good financial habits to have even when the economy is humming along.