Highlights:
A recession is a period of economic decline that historically lasts 10 to 17 months.
Preparation is key in surviving a recession. Reevaluate expenses, prioritize building cash reserves and funding your core long-term goals.
The amount of cash reserves are dependent on the stage in your career and anticipated major life events.
Wealth is often made in a downturn and harvested when the economy recovers. Proper reserves and Dollar Cost Averaging will position you to take advantage of the down market.
Sticking to a well founded financial roadmap and avoiding knee-jerk reactions are key.
Are we in a recession?
According to the general definition of a recession—two consecutive quarters of GDP decline—the United States entered a recession this summer (2022). The National Bureau of Economic Research (NBER)—the authority on determining the start and end dates of a U.S. recession--has not yet declared the U.S. to yet be in a recession.
The reason for this may just be because the U.S. looks to be in what is called a rolling recession—when the recession impact only some parts of the economy at a time. This makes sense as some areas of the economy are starting to pull back while others are still stable.
The forecasts, however, are looking a bit bleak as growth continues to slow and the Federal Reserve continues to raise the prime rate. According to JP Morgan Chase Bank and Morgan Stanley, a full recession is likely over the next six to nine months.
How long does a recession last?
Although there isn't a hard rule on how long a recession lasts, we can look back at previous downturns as rough estimates. The NBER states the average duration is 17 months, with post-World War II recessions averaging 10 months.
If we estimate the recession will officially start in 6 months and last for 10 months, the recession should be over in February/March 2024. If the recession starts in 6 months and lasts for 17 months, the projected end would be September/October 2024.
When will the market consolidate a bottom and when should I start buying?
Markets tend to consolidate around a bottom 6 to 10 months before the economy hits its bottom. This holds true for eleven of the past twelve recessions, with the 2001 recession being the only outlier. In 2008, the S&P 500 bottomed out in March 2009, but the economy didn't start to rebound until June 2009.
Since each recession is different, timing the market or waiting for it to rebound is not typically a wise decision.
So, what's the best way to approach continued market volatility and the threat of a worsening economy?
As with most things, preparation is key. Fortunes are made in an economic downturn but harvested when the market rebounds.
Taking a proactive approach to reducing unnecessary overhead and redirecting spending to take advantage of the downturn can lead to great opportunities for future growth. If an opportunistic approach isn't possible, the focus should be on mitigating risks as drawing down assets during a down market will torpedo retirement and investment nest eggs
Here are some best practices to consider.
1. Identify priorities.
Financial priorities are driven by your current financial situation, lifestyle, life goals and anticipated major life events.
Are you currently working toward an overarching career goal or similar?
Familiarize yourself with spending areas. Often in a healthy economy we get comfortable spending and pursue niceties. These same niceties can lead to unnecessary hardship in a downturn. The objective here isn't to cut spending immediately but to identify areas to cut in the event there's pressure on cash flows.
Revisit cash reserves. How much cash do you have on hand and how quickly can you access cash if your reserves get low?
Familiarize yourself with your debt. How much debt are you carrying? How much is high interest, such as credit cards, and how much is low to moderate interest such as a mortgage?
Identify unpaid expenses. Have you booked a vacation or taken on another financial commitment that us not yet paid for?
Do you anticipate any major life events? Major life events are another form of unpaid expenses that have significant financial impact. The most common are having a child, getting married, making a large purchase, and retiring.
2. Make a plan around your goals.
Now that you've taken inventory of your financial situation, it's time to reevaluate priorities and set objectives.
Prioritize essential expenses and critical goals in the event there's a disruption to earnings or cash flow.
Build Reserves. Many factors influence the need for reserves. Consider the following reserve levels and rationale:
6 Months in Reserve:
Six months of reserves may be adequate for those new to, or just entering, the workforce. In a prolonged downturn, this cohort has the most flexibility in replacing income.
6 months of reserves may cover time of unemployment. 12 months of reserves will provide added flexibility and may provide the opportunity to participate in a down market to grow a nest egg.
12 to 24 Months in Reserve:
High-earners and those with more established careers are most costly to a business and have the most difficulty finding a new career opportunity.
12 months of reserves is likely to cover time of unemployment as the job search for this cohort tends to take longer than anticipated. 24 months will increase flexibility, help reduce anxiety during the downturn, and may enable participation in the down market to position for future growth.
24 to 36 Months in Reserve:
If you own a business, there can be increased pressure during an economic downturn if the business needs funds to make payroll or bridge the gap from the selective bill paying that is common in a recession.
12 to 24 months of reserves may be adequate on a personal level but depending on the balance sheet of your business or other outside interests, 24 to 36 months will provide for better security and any excess may be used to take advantage of the down market to position for increased growth on the upswing.
Redirect spending if desired reserves are not met. If the needed reserves are not met, redirecting spending from unnecessary areas to bolster reserves is never a bad decision. If you find yourself with excess reserves as the market and economy start to rebound, the excess reserves may always be used to take advantage of a rebounding market.
Evaluate where your reserves are held. Where reserves are held is just as important as the amount in reserves. If reserves are held in illiquid vehicles, such as a Certificate of Deposit (CD), the cash cannot be readily accessed. If the reserves are held in an individual investment account, withdrawing during a downturn will lock in losses from the down market.
Take a hard look at High Interest Debt.
The majority of Americans carry significant amounts on credit cards. Even if the entire balance is paid during normal times, an immediate hit to cash flow from loss of a job may make this difficult. Either way, consider paying down high interest debt if possible, but only if it will not reduce reserves to a dangerous low.
Making a plan to service the debt with your emergency cash reserves may be the more appropriate strategy since depleted reserves from paying down the debt may lead to using the high-interest debt to make ends meet from lack of cash.
Reevaluate large purchases. Rising interest rates increases the cost of servicing debt and increased economic volatility increases the likelihood of cash flow disruption. Together, is only prudent to revisit large purchases. Unless absolutely necessary or if cash reserves can easily bridge prolonged unemployment, delaying large purchases may be wise.
Consider your career and business opportunities. A recession always results in large unemployment rates. Consider how a job loss would impact your finances and think through a backup plan. Rekindle connections, refresh your resume, connect with recruiters, and familiarize yourself with job search platforms and tools. Moonlighting or a side business can create additional streams of income to reduce stress and pressure on emergency funds. An often-overlooked area to consider is continuing education and expanding your skill set. During times of strong economic growth, skill development is often overlooked because the headwinds to career growth are replaced by the need to fill positions to accommodate growth. Economic downturns may present the unique opportunity to advance your skill set or pursue a different career altogether.
Revisit your Risk Tolerance. During times of economic prosperity, it's common to take on risk we wouldn't otherwise be comfortable with. Now that the markets are wonky and the economy is sputtering, it's time to revisit our risk tolerance, and if possible, reposition ourselves to mitigate risk and realign our holdings with our appetite for downside risk.
Invest at a consistent rate. Maintaining cash reserves and setting a consistent investing schedule can be considered the silver lining of an economic downturn since it provides the opportunity to take advantage of the down market. Dollar Cost Averaging—where a predetermined amount of money is invested on regular intervals—will help limit losses in a shrinking market by limiting the number of shares purchased at the height of a bull (growing) market. The same tactic will result in purchasing more shares during a down market leading to greater growth when the market rebounds since the additional shares will grow in value.
3. Avoid knee-jerk reactions.
Knee-jerk reactions and decisions made out of stress and fear are cardinal sins when it comes to financial stability and prosperity during economic volatility. If you've already committed to a well founded financial roadmap and the path to prospering during a downturn has already been laid, it's likely best to stick with it. Leaning on your financial advisory team during times like these are crucially important.
If there's reason for doubt in your financial roadmap or if circumstances have changed, it's time to revisit with your advisory team. If you don't have an advisory team, now would be an opportune time to establish an advisory relationship. The reduction in stress and increased confidence in your financial direction will be well worth the investment.
If you find yourself contemplating the best way to move forward, we're always happy to provide a complimentary review.
Please contact us at: info@stanleywealth.com
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