The dreaded "R word" is back on Wall Street. A weaker-than-expected July jobs report and downbeat news on U.S. manufacturing earlier this month raised fears of a coming recession.
And while a recession isn't here yet and a hoped-for soft landing can't be ruled out, now's the time to prepare for the next economic downturn.
"It's probably not entirely possible to fully recession-proof your finances, but what can be accomplished to some degree is insulating your (portfolio and life) from a downturn," said Ryan Graham, managing advisor at Altfest Wealth Management.
You can't control market volatility or a job layoff. But there are steps you can take to minimize the pinch caused by bearish outcomes caused by a recession. The big threats when the economy contracts include a job loss and steep declines in the value of your investments. Also guard against the inability to pay your bills.
But preparing for the worst isn't all about doom and gloom. It's really about making sure you and your family will be able to ride out a financial storm. Here are ways to insulate your life from recession.
Ramp Up Cash Reserves For Recession
Having a well-stocked emergency fund during an economic downturn is akin to having an umbrella handy during a rainstorm. "It can really be a make or break, especially if you (get) laid off," said Jordan Mangaliman, investment advisor at Goldline Financial.
An easily accessible rainy-day fund held in a high-yield savings or money market account is like an insurance policy. It should cover at least six months of living expenses. Twelve months gives you even more protection. "If someone doesn't have an emergency fund in place, we recommend putting that in place," said Ryan Patterson, chief investment officer at Linscomb Wealth.
So, look if your savings jar is empty or low. Also see if you're sitting on profits from the stock market or your asset mix has gotten too stock-heavy. If so, now's a good time to rebalance your portfolio and boost your cash holdings.
But be conscious of the tax impact of any asset sale. It's better to sell long-term gains in your brokerage account. Those have the more tax-friendly capital gains treatment. It sure beats taking a distribution from a traditional retirement plan, which is taxed as ordinary income.
Review Your Budget And Pay Off Debt
If money could be tight down the road, this is not the time to run up high-interest credit-card debt. Don't bust your budget with undisciplined spending, either.
"It's time to reduce debt," said Mangaliman. "It's time to build up cash reserves and do a strong budget review. Credit-card debt and impulse purchases can really crush you during a recession."
Insulate Your Investments From Big Downside From Recession
Going to all cash to avoid market losses isn't viable. Timing the market is a fool's game. But there are portfolio moves you can make to protect against outsize losses. You can also give your portfolio a more defensive feel if economic conditions deteriorate.
One way to protect against catastrophic losses is to make sure your portfolio is properly diversified with stocks and bonds. Your asset mix shouldn't be too overweight in the riskiest, most volatile assets.
"Diversification becomes even more critical during a recession," said Graham.
Stocks that tend to get hit the hardest during economic downturns, for example, are companies that sell discretionary products and services. That includes restaurant, travel, entertainment and luxury companies, which sell products and services that consumers can live without, says Graham. Other volatile sectors during downturns include technology stocks, which are currently trading at rich valuations. Trimming back holdings in these areas can be prudent.
"These more volatile sectors can witness much heavier declines during a recession compared to more defensive sectors like utilities, health care or consumer staples," said Graham.
Build A Stream Of Steady Income
Liquid assets and guaranteed income are in high demand during recessions. So now's the time to build a steady stream of income. You can build a CD ladder or Treasury-bond ladder, or both. This strategy involves spreading money across multiple certificates of deposits or Treasury bonds with different maturity dates. This allows you to lock in higher yields for longer. But it also gives you access to cash you might need in regular intervals.
"This should provide you with needed income, and these assets also shouldn't decline as much in the event of a recession," said Graham.
Fixed-income and cash are steady income generators. But they also provide added diversification to your overall portfolio. "For the most part, fixed income is typically a pretty good buffer to equity market volatility," said Patterson.
Consider Buffer ETFs For Recessions
Worried about suffering a bear-market loss of 20% or more on your stock holdings due to recession? If so, consider investing in a new type of ETF that defines your investment return in advance. So-called buffer ETFs, or defined-outcome ETFs, give you upside exposure to an index such as the S&P 500. But they limit your downside risk in the event that the market tanks.
Here's a hypothetical example: Say you buy a buffer ETF that tracks the S&P 500 and caps your upside at 15% but limits your downside to 5% in the next 12 months. If the benchmark stock index gains 20% in the next year, your gain would be 15%. In contrast, if the S&P 500 falls 20%, your loss will be limited to just 5%.
Don't Forget About Career Planning
Recessions and job cuts go hand and hand. So, get your resume up to date and highlight all your job wins, says Mangaliman.
And, if you haven't already, start networking. Invest in your work skills to broaden your appeal to your current boss and prospective employers. The workplace is undergoing massive change, such as the emergence of AI.
"The marketplace is always evolving," said Mangaliman. "So, how do you enhance your job security? By taking on additional responsibilities, showing initiative at where you work now, and continuing to remain valuable to your team."
Mistakes To Avoid Heading Into A Recession
Sometimes, investors can put themselves in a vulnerable position. The most common investment mistake before a recession strikes and stocks turn south is putting too much money into a single stock or sector. Beware of concentrated portfolios, as having too many eggs in the same basket can expose you to potentially larger losses than holding a diversified portfolio.
Liquidity, or the ability to get access to your money quickly without any tax consequences, is key in tough times. Make sure all your money isn't locked up in tax-deferred retirement accounts. These accounts get socked with a 10% IRS penalty for early withdrawals. Additionally, early withdrawals are taxed at your usually higher ordinary income rate if not a Roth account.
"When cash is needed, traditional retirement accounts (that are funded with pretax dollars) are not the accounts you want to be relying on" to raise cash to pay bills, said Graham.
Raise Cash Early In Recession
One way to raise needed cash before storm clouds appear is to consider temporarily paring back contributions to your 401(k). Instead, funnel that freed-up cash to a brokerage account or savings account.
Another no-no is making financial decisions based on fear, especially if assets you own start to fall in value.
"One of the biggest mistakes that people make is making big decisions based on emotion during stressful times," said Patterson. So, avoid selling out at market bottoms or hiding all your cash under the mattress earning zero interest.
It's good to have dry powder to buy assets that have suffered steep losses and selling at more attractive valuations due to recession, adds Mangaliman. "Recessions are a great time to get into companies that you thought were too expensive," said Mangaliman.
The bottom line: Don't let a recession catch you and your finances off-guard. "Be prepared," said Mangaliman. "Because if you're not, a recession can take down your portfolio and personal finances."
