5 Steps To Prepare & Profit From A Recession
In this article, we will discuss the steps that anyone can take in order to prepare for the upcoming recession and even make better returns than you've ever made before. However, before we get there, there's a few things that we need to discuss because what even is a recession? how often do they happen when they happen? what does that mean for the stock market? and how long does it take for things to actually recover?
Recessions are defined in two different ways:
One of them is looking at the stock market performance. Whenever you see a drop of 20% or higher, we're in a recession. The Government however relies on GDP - Gross Domestic Product and whenever we have two consecutive quarters of declining GDP, then that means that we've entered a recession.
Now real people define recessions based on what they see around them and one of those things is increased unemployment. This of course makes it harder for people to get jobs, which also means that layoffs are happening everywhere. Another symptom is reduced balances in retirement accounts such as IRAs and 401ks and this is because the stock market is coming down. Interest rates and applications for new loans such as mortgages and car loans are actually on the decline, while news outlets continue showing you the same red charts over and over 24/7.
US Recession Facts:
Our economy actually moves in cycles. Cycles of expansion and cycles of contraction. Whenever we are in an expanding portion of the cycle, then things are good, people are making a lot of money, people are spending a lot of money, CEOs are making millions of dollars off of bonuses alone and the party seems like it's going to continue going forever. But this behavior cannot continue forever and when that happens, that's what we call the bubble bursting and that means that the economy and the stock market tends to take a dip.
In the case of the US economy, even though we have experienced 12 recessions since World War II and the stock market has actually contracted during those periods, overall once you zoom out you see that the stock market has actually grown over long periods of time and that's why they say the millionaires are made in recessions. Because those who have the means to navigate these recessions are able to buy great businesses at discounted prices.
In terms of frequency I mentioned that we have lived through 12 recessions since World War II that means that on average they're happening every 6 and 1/2 years and while they may take a little bit more or a little bit less time to happen, one thing is for sure and is that there is always going to be an upcoming recession.
Over the last 10 recessions, the average drop has been of 31%, while the 2008 recession was of about 50%. Additionally, the average recession since World War II has lasted 11.1 months, with the longest one being the Great Recession which started in December of 2007 and ended in June of 2009 for a total of 18 months.
Recession Prep Work
1. Emergency Funds:
When we're talking about preparation, the most common thing to happen is for unemployment rates to spike up. The best way to prepare for such an event is to have an emergency fund or cash reserve of 3 to six months worth of expenses. In the unfortunate event that you are actually laid-off, you have enough money set aside for you and you family to get by for a few months at least. This will also be beneficial in that you won't have to sell any of your current investments in order to be able to cover for your living expenses. This is the worst case scenario because imagine that you've been laid-off, you don't have a steady flow of income and you're currently holding Investments that have probably gone down in value because the stock market is crashing and now you're actually forced to sell those Investments at a reduced value just to be able to cover for your living expenses. This must be avoided at all cost.
Let me put into perspective what happens if you actually don't have an emergency fund set up. Unfortunately, these are the kind of situations where people end up going into debt because they have to borrow money, perhaps even against credit cards, just to be able to cover their living expenses. They later start defaulting on their loans, defaulting on their mortgages, getting their car repossessed, and even end up filing for bankruptcy.
2. Job Security
While there is no guaranteed way to increase your job security, ensure that your job won't be affected during a recession or that even your employer will still be around during a recession, the best way that you can prepare for one of these situations is by actually stepping up your performance. For example: let's say that you're currently working in a team that has five people and the company now needs to lay off three of them. If you are one of the top performers then chances are you have a better shot at staying around and in the topic of recessions that means that you have a steady flow of income coming into your pocket. That means that you're able to cover your living expenses and you also have a little bit of money aside that you can put into investing.
3. Mortgage Sizing
This step can be summarized in four words “Don’t be house broke.” In other words, don't purchase more house than you can actually afford, because if you were to be affected during a layoff or you have to take a pay cut, then the amount of money that comes out of your paycheck every month just to cover for a mortgage payment is actually going to wear you down faster. It will even prevent you from being able to take advantage of an opportunity like being in a recession to buy great businesses at great prices.
Unfortunately, I actually have a close example of somebody who lost three houses during the last 2008 recession and this was because they themselves couldn't keep up with the payments of these houses once their tenants stopped paying rent. Why did the tenants stop paying? because they had also lost their jobs.
Although I don’t subscribe to general rules about what percentage of your paycheck should be assigned to your paycheck, I will issue a word of caution. Understand the all-in cost of owning a home: mortgage, insurance, taxes, repairs, etc. Before you make a new home purchase, understand how these amounts of home expenses play into your budget. Also, back in step 1 we talked about building an emergency fund to cover for your living expenses during a downturn. Needless to say, your emergency fund needs to account for the monthly all-in cost of your future new home.
Profiting From a Recession
4. Dollar Cost Average
Finally we get into the portion where we're talking about how are we actually going to make money during our recession, because like I said before, this is where millionaires are made. You may have heard of the term DCA - Dollar Cost Averaging. What it simply means is that you define an amount of money that you can comfortably invest every single month and you commit to it. Every single month you buy into the market with that defined amount of money. If the market goes up, then you with the market. If the market goes down, then you buy with the market. At the end of this process, which ends when you sell your stocks or index fund, you’ll have bought the average return of the market.
Plenty Of Studies have already shown that this is a better winning strategy for most people as compared to those who try to sell at the very top and buy again at the very bottom. This is because most people can't tell where the top is going to come in and when the bottom is going to come.
Fun fact: studies have shown that men tend to self-rank themselves as more knowledgeable investors (than they truly are). This in turn leads them to pick individual stocks and actually trade them continuously, elevating their tax liabilities and over time actually reducing their returns as compared to women. Women actually tend to self- rank themselves as less knowledgeable investors and stick to proven strategies such as DCA. Remember, dollar cost averaging is a simple and proven strategy that works over time.
The best way to take advantage of dollar cost averaging is to start buying immediately when you have the money available. Don't wait for a recession to hit, don't wait for a 20% drop in the stock market. Start dollar cost averaging today into the market and as the market continues to do its thing, you continue to make more purchases at different levels.
5. FUD and FOMO
If you don't know these terms, FOMO means fear of missing out and FUD means fear, uncertainty and doubt. I actually learned this lesson the hard way because when I started investing I read “The Intelligent Investor” (book) and one of the things that this book warns you about is paying attention to news outlets and investing based on what you're hearing in the news. Back in 2013 when I started investing, if you turned on the news channel that covered the different markets and stocks, I can tell that every single year until 2024 all I heard was that the economy was going into a recession, a recession is inevitable, and this is the year that it's happening. That actually prevented me from going all in into my investing as I was waiting for a good entry point.
My mistake? I was playing too much into the fear-mongering that was going on in the news outlets. So what should we all do instead? I’m not saying you should never listed into news outlets, earnings calls, or other kind of news. All I’m saying is to define an investing strategy and don’t deviate from it regardless of what news anchors are saying.