How Do Investors Prepare For A Recession?

Key Takeaways

• Getting your financial house in order is critical to surviving a recession and even the current level of volatility in the market.
• Investors need to understand a recession, bear market, and bear market rallies to limit losses.
• Take advantage of the slow economy to save money and make money.

With fears of a recession looming, many investors want to know what they can do to protect their money. Below are a handful of tips that will put you in the best financial position to weather any recession and possibly even profit from it.

Is It Too Late To Act?

By the time you are reading this, you have probably already lost a significant amount of money on the year. This is why experts say no one can beat the stock market. It begins to react to rumors well before negative news happens.

For example, there is still talk about a possible recession, and the market is down over 20% for the year. Higher-growth technology stocks are down anywhere from 30% to 70%. If a recession does hit, odds are the market will drop further. So the first thing you need to do is always stay on top of your finances, regardless of whether times are good or bad.

What you should not do is throw in the towel. Even though you have lost some money, you can lose more if things get worse. Back in 2008, the stock market lost close to 50%. In other words, you can act now and still protect yourself.

Review your investment plan

It is critical that you review your investment plan. If you don’t have a plan, now is the time to make one. Your plan should cover why and what you are investing in, your risk tolerance, and your time horizon.

Having an investment plan helps you navigate tough economic times because we all get emotional, especially about money, and are susceptible to making bad decisions. Having a plan can limit emotional decisions because you’ll have some clearer goals and guidelines to ground those decisions.

Finally, make sure you update your investment plan regularly. This doesn’t mean you need to reinvent the wheel at the start of every year. But, every five or ten years, as you age, your asset allocation should likely change, because your goals will change. Updating your plan gives you a guide for making better investment decisions.

Take a long-term outlook

When bad times hit, and the market drops, we get nervous or scared and want to react to short-term pain. But you need to keep a long-term outlook. You need to understand that in time, the stock market will come back, and the economy will improve. It always does.

In fact, the average recession lasts just ten months. The average bear market lasts 289 days, that’s less than one year.

The bear market in 2008 lasted longer, 18 months. But the result was the same. The stock market and the economy came back.

As difficult as it can be when things are bad, you need to focus on the long term. If you find it difficult, turn off the news, stop reading about the economy, and stop checking your investment account balances every day. The less you are exposed to negative information, the less likely you are to react (or overreact).

Don’t get fooled by market rallies

A mistake many investors make is to get caught up in bear market rallies. These rallies are often defined as increases in the stock market of 5% or more during a bear market. The pessimism from a weak economy subsides, and optimism takes over. As a result, the stock market rallies.

The problem is this is just a temporary rally. The optimism will fade as more bad news comes out. The market is likely to retreat once again. Some investors take this rally to mean the recession is over and subsequently start investing again, only to lose money when the rally ends.

It is vital that you know bear market rallies happen all the time. Investors should try to stay on top of economic reports, taking them all into account. If one is positive, but the others are still negative, chances are the bear market won’t end anytime soon.

Build your investment rainy day fund

A smart move is to have cash on hand to take advantage of a drop in the stock market. This allows you to buy low and sell high in a few months, or years, when the market fully recovers and you’re ready to sell.

Some like to have 5-10% of their portfolio ready to invest, while others like to have higher amounts. It all depends on your financial situation. The key is not to invest everything at once. As mentioned above, there are rallies during a bear market.

You want to pick and choose when to invest, and you want know when a stock has hit the bottom. In other words, you might think the current price for a stock is cheap, so you take a position only to have the stock drop another 3%.

Timing the market is nearly impossible, and usually has more to do with luck than skill, so your goal here is to do your research and buy when you think the stock is undervalued. If it goes down a little more, then you can buy more. After all, if your research showed it was a good buy at a higher price, it’s likely going to be a better buy at this lower price.

Pay off high-interest debt

Another critical financial move when a recession is coming is to pay off as much high-interest debt as you have. You never know how long the economic downturn will last, so you need to maximize the money you have available for everyday living expenses and investments.

If a large portion of your monthly income is going towards debt, it’s harder to make ends meet. Add in possible job loss or reduced pay, and your finances get much more complicated and stressful in a hurry. Therefore, do what you need in order to pay off all or at least some of your existing debt. This could mean taking a second job or working a side hustle here and there.

Understand your job situation

Without a job, you have no money coming in, and there are no guarantees when it comes to employment during a recession. Depending on the recession’s severity, many employers will lay off workers, just look at what’s happening in tech today.

You should take an honest assessment of your job security. If you think you are a candidate for a layoff, is there anything you can do now to lower that likelihood? Is there a skill you could learn that makes you more valuable to your employer? Could you take on more responsibility, making it harder for them to let you go? Or even a colleague relationship that needs to be improved?

Even if you put in the work, there is still a chance that you will lose your job. Therefore, you need a backup plan. What will you do for income? Are there any businesses or companies you want to work for? Being unemployed is stressful, but a plan can help ease some of that stress.

Make sure you have an Emergency Fund

An emergency fund can be the difference between surviving a recession and failing way behind where you’d hoped to be. Most experts recommend having six months’ worth of living expenses in your emergency fund. Depending on your risk aversion and situation, you might want more. You really don’t want less. The more money you have to fall back on, the less stress you’ll feel.

For some, this kind of savings seems out of reach. This is a great time to review your spending habits and try to cut back. Do you need three streaming services? Can you shop around for insurance coverage to save money? Can you sell your car and buy a less expensive used car?

Profit from the weak economy

Finally, there are some things you can do to get ahead financially when the economy is weak. First, keep an eye on interest rates. While the Federal Reserve is increasing rates to lower inflation, during a recession, it will eventually pivot and begin to lower rates to get the economy moving again. If rates drop below what you are paying on your mortgage, consider a refinance to save money.

If your finances are in good shape, you can reach out to employers you would love to work for. While they are cutting jobs, you can get hired if you agree to a lower salary. Have an agreement so that as the economy improves, your salary will increase in turn.

Another option is to be on the lookout for deals. Retailers will slash prices to move inventory. Contractors might be looking for work. Others might be selling things for cash so they can survive. You might get great deals if you want to update your home or buy a sofa or a car. But you can only take advantage of these deals if your finances are in a good place.

Bottom Line

Following these tips can protect the money you worked so hard for. But these tips won’t guarantee you don’t lose money or your job. Anything can happen during a recession, and losses occur all the time. The key is to build a safety net so that you minimize losses and then can profit on the other side.

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