A recession is potentially heading toward us with the destructive power of an onrushing freight train. That's the perception of many Americans. Some folks fear a recession is already here.
If they're right, a key question for everyone is what should each of us do about it?
Leading financial advisors urge affluent, financially sophisticated people to take six steps to gird themselves for a recession.
Step 1: Get Your Stock Portfolio Ready For Recession
The conventional wisdom for stock portfolios in recession? In a time of economic weakness, fund shareholders should bulk up on consumer staples, utilities and bonds. Likewise, they should lighten up on industrials, materials, banks and technology holdings.
But it's too late to make many such traditional defensive moves, says Paul Schatz, president of Heritage Capital. "The stock market has (already) largely discounted a mild recession in 2023," Schatz said.
Yet there are steps you should take if they fit your overall investment plan for the diversified fund portion of your portfolio.
Among stock ETFs, Schatz likes $3.7 billion iShares US Aerospace & Defense ETF. It's a play on military spending. "The defense industry is strong and the group has lost less," Schatz said. The fund is down 1.09% this year vs. an 18.60% loss for the S&P 500, going into Thursday, according to Morningstar Direct.
Step 2: Prep Your Bond Portfolio For Recession
Schatz also likes certain bond funds at what he sees as this stage of a slide toward a potential recession.
"I would start looking at bonds to buy in the coming weeks and months," said Schatz, who is also vice president and treasurer of the National Association of Active Investment Managers.
If you prefer passively run ETFs, Schatz nominates $75.5 billion iShares Core US Aggregate Bond ETF and $32.2 billion iShares iBoxx $ Investment Grade Corp Bond ETF.
AGG is an intermediate core bond fund. Its SEC yield is 4.24%. Its total return year to date is -15.41%. LQD is a corporate bond fund with an SEC yield of 5.88%. It has fallen 21.93% so far this year.
Both bond ETFs have effective durations longer than their category's average. The longer a bond ETF's duration, the more sensitive it is to interest rate changes. Typically in a period of fast-rising rates as now, investors would shun both funds. Additionally, the Federal Reserve is likely not finished with interest rate hikes.
But Schatz sees better days ahead for these ETFs anyway. "I think the bond bear market is at beginning of the end or even further along," he said. "When the tide turns, funds like AGG and LQD will likely bounce the most and lead as they are passive."
Expecting an actual recession in the first half of 2023, Schatz also likes certain actively managed ETFs.
One he recommends is $2.6 billion Janus Henderson Short Duration Income ETF. It's an actively run ultrashort bond ETF.
Schatz expects active mutual funds to bounce back less dramatically than passively run funds. But active mutual funds whose prospects he likes are $14 billion Western Asset Core Bond I, $221.2 million JPMorgan Corporate Bond A, $12.9 billion PIMCO Investment Grade Credit Bond I-3, $61.4 billion Metropolitan West Total Return Bond M and $17.9 billion Guggenheim Total Return Bond A.
He likes their long-term records. Also, the fact that they've suffered big setbacks this year positions them for big bounce-backs, he says.
"The active managers have already shortened duration and/or hedged some exposure," Schatz said. "(They) are all active mutual funds with strong track records that have been hit hard this year."
Your portfolio isn't the only aspect of your personal finances that needs protection from a recession, advisors warn.
Step 3: Right-Size Your Cash Flow
If recession is coming, it's time to look at your spending. So says Jamie Hopkins, managing partner of wealth solutions at Carson Group. What he means is batten down your financial hatches. Make sure your income exceeds your spending.
"This is not just budgeting or cutting back," Hopkins said. It also means "making sure you are spending on the right things."
If you dine out often, for instance, eat one or two more meals at home if you can.
Step 4: Build Your Emergency Savings
If you get laid off or a hurricane destroys the roof of your home, you need savings that you can tap into in these perilous times financially. That way, you won't rack up costly credit card debt amid a recession or a threat of one. And you won't deplete your retirement savings, triggering potentially expensive early withdrawal penalties and taxes.
How much emergency savings do you need? Enough to pay all of your bills for three to six months, Hopkins says.
Step 5: Refinance Costly Loans
With rates rising, now's the time to lock some in. Consolidate high-interest-rate credit cards to one that charges less on outstanding balances. Or consolidate to a card that lets you delay payments for several months without penalty, Hopkins says.
With mortgage rates rising — which is one of the factors contributing to fears of a recession — it's hard to refinance to a lower-rate loan. "But if you extend out duration, you might spread out your payments, lower your monthly payment and potentially reduce some costs," Hopkins said. In other words, if you've got a 15- or 20-year mortgage, shop around for a 30-year loan with a lower rate.
Step 6: Get Rid Of Variable-Rate Loans
Generally, rates on variable-rate loans are rising along with interest rates. Replace them with fixed rate loans that won't rise more. Personal loans, student loans, credit cards and mortgages can all carry variable rates, warns Lyle Solomon of Oak View Law Group, who has a focus on debt relief.
Always calculate how cost-effective refinancing a home is before doing it. Total the closing costs. Then divide that by the amount your new loan would cost each month. If the savings pay for the closing costs in three years or less, it's a good deal on the face of it. If it would take more than three years to reach break-even, "you are taking a risk that you might move before that time and never see the benefits," Hopkins said.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
