March 28, 2022
Monday PM

(SitNews) Ketchikan, Alaska - Don’t be alarmed when you hear we may be heading into a recession. Instead, be ready. From my perspective, I see a good chance that the US and possibly Europe will go into recession before or by winter of 2022. If I am wrong, being prepared is still going to help you, so pay attention to the possibility and take some preventative measures now. Just in case.

What is a recession, specifically? Experts define recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” (The National Bureau of Economic Research/Liz Ann Sonders, Chief Investment Strategist at Charles Schwab). It includes a lot of details that I will not bore you with here, but which are closely observed by panels of pretty smart people who keep track of trends and details.

Currently, given the odd series of problems out there, from the pandemic to supply chain issues to rising prices (inflation) but low unemployment and rising wages, it is hard to pin down the exact reason why the US may be heading into recession. We as a nation have never had the kind of pandemic experience that we are now coming out of (I hope) so it is hard to pin the blame on the virus alone. It is not just because prices have risen dramatically, either. We have also not previously experienced a high employment rate and rising wages along with a general feeling of pessimism across the entire population. We are in strange territory no matter how you measure. Nevertheless, there is growing evidence that recession may be on the horizon shortly. I tend to think this will turn out to be correct. If so, there is work to do.

Your money will be affected by a recession, because one of the first things to happen in a recession is that the Federal Reserve will raise interest rates. In fact, they have already said that they are concerned enough about inflation to begin to raise interest rates, and do so more than once. When the Fed raises rates, banks and credit unions will raise their rates also. In addition, any variable rate you have on personal loans, car loans, credit cards and other types of loans will also go up, sometimes dramatically. The cost of borrowing will go up.

However, rather than getting into a panic, sit down and take inventory. You can avoid a lot of stress and damage if you stay calm and do that all-important financial review now, not later. Being prepared for the worst is way better than the uncertainty of wondering if you will survive the damage that a recession can do. So, how do you get ready for a recession anyway? Read on.

Start with a fresh inventory of all of your assets and debts. The value of the assets should always be greater than the value of the debts. The difference between your total assets and your total debt is your “net worth”.

For example, if your home, your car(s), your savings, your retirement plan balance, your investments or other real estate (if you have them) are all worth $750,000, and your mortgage loan, credit card balance(s), car loan(s), other real estate loans or personal loans are $400,000, then your net worth is $350,000.

To be financially healthy, your net worth should be a positive number, not a negative number. In addition, it should increase over time as you pay off loans and acquire more investment assets for retirement. If it is not a positive number, your first step is to pay off, or at least reduce those debts. Get rid of as much debt as possible. Start with credit card debt and high interest payment plans like car and boat loans or personal loans.

Pay off the loans that cost the most in interest charges before worrying about reducing your mortgage debt, but if your mortgage is variable, now is a good time to convert it to a fixed rate loan. Later, when you have no debt other than a mortgage, you can use the money you were previously paying on those other debts to make extra payments against the principal of your fixed rate mortgage. This will save you a lot of money in interest payments over the life of a fixed rate mortgage. You could also build an emergency fund for maintenance and repairs on things that wear out or break, like car tires, refrigerators and other larger ticket items that are unplanned but which always present, usually at a bad time. Being prepared for them is good money management.

Next, list all of your routine monthly, quarterly and annual bills for necessities, like rent, mortgage, utilities, groceries, insurance premiums, gas, subscriptions, educational loans, medical bills or premiums, and other bills that are routine and predictable every month or quarter.

If you are self-employed, you also need to acknowledge the expense of self-employment and income taxes that you either pay quarterly or annually when you file your federal income tax return. This is sometimes a pretty large dollar amount and for some reason, many people during the early years of being self-employed do not set aside the cash that they will owe for self-employment/income taxes.

After factoring in taxes, you should next add up all of the money you spend on non-essential things, like restaurants, vacations, travel, donations, clothes and entertainment.

For example, if your gross income is $5,000 per month, and your expenses are taxes of $700 + necessities of $2,500 + discretionary spending of $2,000, you are routinely overspending by $200 per month on average. The result of regularly overspending is that you will be piling up more debt or using your savings to pay for your overspending. You will need to stop doing this since it will sabotage your future, especially when interest rates rise.

A common question I have heard over the many years of advising clients is what to do about investments during a recession. Should you make changes in how you invest? Should you get out of stocks? Should you get out of bonds? Should you go to cash? The answer will depend on how your entire portfolio of investments is allocated. What do I mean by that?

How your portfolio is divided into different categories of investments is called “asset allocation”. It is one of the most important strategies to investing successfully, in spite of recessions, good or bad times, bull and bear markets. The strategy is simple: invest your money in different categories. Examples of different categories are stocks that pay dividends, short term bonds, tech sector stocks, financial stocks (banks, insurance companies etc.), industrial stocks (machinery, equipment etc.), health care stocks, municipal bonds, cash and many more. Each category is different from the others, so you are not putting all of your eggs into just one basket. You are spreading it around, and this reduces the risks.
For example, if you have$100,000 in an investment portfolio, a good strategy for asset allocation might be to have $10,000 invested in 10 very different categories. For more information about this strategy, see my prior columns in the archived section of Sitnews to get a better idea of how to do this.

When the US goes into recession, every category of stocks, and bonds as well, will be affected in some way by rising interest rates, inflation and a slowing economy. Some will benefit and others will not. Spreading the risk is always a good strategy no matter what is going on with the economy, but particularly during a recession. So, if you are looking for ways for your investments to survive a recession that looks very possible at the moment, now is a good time to do a review of your portfolio to make sure that you have not put too many eggs in one basket. A little tweaking once in a while may be necessary and helpful.

Recessions are not permanent. At some point they end. Historically, US recessions over the last 50 years have lasted from about 6 months to about 18 months on average. Some of these recessions also experienced a bear market for stocks and some did not. A bear market on stocks is when the prices of stocks drop dramatically, either suddenly or over time. By the way, bear markets are not all bad; they offer investors the opportunity to buy perfectly good stocks and stock funds at bargain prices. If you stick with good quality stock funds, buying shares in a bear market is like shopping at Nordstrom’s annual half price suit sale. You end up getting good quality at sale prices. It works with stocks as well as wool suits.

Given that the general pattern of any recession is that the economy slows down, it is logical that this will have some kind of impact. What kind of impact depends on how people respond to the slow down. The impact on your and your household will depend on how you manage your finances prior to, during and after a recession. Taking steps now to reduce or eliminate your debt by controlling your spending and being careful to allocate your invested dollars by diversify into different categories, are the two ways to get through a recession with minimal difficulty. If I am right about the US going into recession in the next two quarters, you will be glad you did. If I am wrong, you will also be glad you did, because you will have learned the keys to successful money management. And in my book, that’s a win-win.

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