The specter of a recession looms large over the financial landscape, casting a shadow of uncertainty. A recent underwhelming jobs report for July, coupled with disheartening news from the U.S. manufacturing sector, has stoked anxieties about an impending economic downturn. While the economy has not yet succumbed to a recession, and the possibility of a gentle landing remains, it is prudent to brace for the next financial tempest.
"Achieving complete immunity from a recession's effects on your finances may be an unattainable goal," posits Ryan Graham, a managing advisor at Altfest Wealth Management. "However, it is feasible to take measures that can shield your financial portfolio and personal life from the harshest impacts of an economic slump."
Although you cannot dictate the whims of market volatility or preempt job displacement, proactive steps can be taken to mitigate the financial strain that often accompanies a recession. The primary threats during an economic contraction are job loss and a precipitous devaluation of investments, along with the risk of defaulting on financial obligations.
Preparing for the worst is not merely about embracing pessimism; it is fundamentally about ensuring the financial resilience of you and your family in the face of adversity. Here are strategies to safeguard your livelihood against a potential recession:
Boosting Emergency Funds for a Rainy Day
Amassing a robust emergency fund during an economic downturn is as essential as carrying an umbrella on a cloudy day. "It can be the difference between financial stability and chaos, particularly in the event of job loss," remarks Jordan Mangaliman, an investment advisor at Goldline Financial.
An accessible rainy-day fund, ideally housed in a high-yield savings or money market account, serves as a financial safety net. It should ideally cover at least six months' worth of living expenses, with twelve months providing even greater security. "For those without an emergency fund, establishing one should be a priority," advises Ryan Patterson, Chief Investment Officer at Linscomb Wealth.
Conduct a thorough review of your financial reserves. If your savings are depleted or insufficient, consider rebalancing your investment portfolio to increase your cash reserves. Be mindful of the tax implications of any asset sales; it is generally more advantageous to realize long-term gains in your brokerage account, which are subject to more favorable capital gains tax rates, rather than withdrawing from a traditional retirement plan, which is taxed as ordinary income.
Revising Your Budget and Eliminating Debt
In anticipation of potential financial constraints, it is ill-advised to accumulate high-interest credit card debt or engage in unrestrained spending.
"The focus should be on debt reduction," Mangaliman emphasizes. "It is crucial to bolster cash reserves and conduct a rigorous budget review. High-interest debt and impulsive spending can be financially devastating during a recession."
Shielding Your Investments from a Recession's Impact
While it is impractical to convert all assets to cash to sidestep market losses, as market timing is an unreliable strategy, there are strategic portfolio adjustments that can mitigate significant financial losses. You can also fortify your portfolio with a more defensive stance should economic conditions worsen.
Ensuring a well-diversified portfolio that includes a mix of stocks and bonds is one way to guard against severe financial setbacks. Your investment allocation should not be disproportionately weighted towards the most volatile and risky assets.
"Diversification is especially critical during a recession," Graham notes. Sectors that are typically hardest hit during economic downturns include companies dealing in non-essential goods and services, such as restaurants, travel, entertainment, and luxury items, which are the first to be forsaken by consumers. Additionally, technology stocks, known for their volatility, particularly when trading at high valuations, should be carefully considered for reduction in your portfolio.
Establishing a Reliable Income Stream
Liquid assets and a guaranteed income stream are highly sought after during recessions. Therefore, it is wise to create a steady flow of income. This can be achieved by constructing a Certificate of Deposit (CD) ladder or a Treasury bond ladder, or a combination of both. This strategy involves spreading your funds across multiple CDs or Treasury bonds with varying maturity dates, which allows you to secure higher yields over a longer period while also providing periodic access to funds you may need.
"This approach should provide the necessary income, and these assets are also less likely to plummet in value during a recession," Graham explains. Fixed-income investments and cash not only generate a steady income but also add diversification to your overall portfolio. "Generally, fixed income serves as a reliable buffer against equity market volatility," Patterson adds.
Considering Buffer ETFs for Recession Protection
If you are apprehensive about incurring a substantial bear market loss on your stock holdings due to a recession, you might want to explore a new class of Exchange Traded Funds (ETFs) that define your investment returns in advance. These so-called buffer ETFs, or defined-outcome ETFs, offer exposure to an index like the S&P 500 while capping your potential losses if the market experiences a downturn.
For instance, imagine purchasing a buffer ETF that tracks the S&P 500, with a 15% cap on upside gains and a 5% limit on downside losses over the next 12 months. If the index rises by 20%, your return would be capped at 15%. Conversely, if the S&P 500 declines by 20%, your loss would be limited to just 5%.
Career Planning in the Face of a Recession
Recessions often coincide with job cuts, making it imperative to keep your resume current and highlight your professional achievements, as suggested by Mangaliman.
Additionally, it is crucial to network and invest in your professional skills to enhance your value to your current employer and potential future employers. The workplace is in a state of flux, with advancements like artificial intelligence reshaping the landscape.
"The job market is in a constant state of evolution," Mangaliman says. "To bolster job security, take on more responsibilities, demonstrate initiative in your current role, and ensure you remain an indispensable asset to your team."
Avoiding Common Pitfalls as a Recession Approaches
Investors often position themselves precariously leading up to a recession. A common mistake is over-investing in a single stock or sector, which can lead to significant losses due to lack of diversification.
Liquidity, or the ability to quickly access your funds without tax penalties, is essential during challenging times. Ensure that your funds are not entirely locked in tax-deferred retirement accounts, which can incur a 10% penalty for early withdrawals and are taxed at your ordinary income rate if not a Roth account.
"When liquidity is required, traditional retirement accounts funded with pre-tax dollars are not the ideal source for raising cash to meet financial obligations," warns Graham.
Securing Cash Flow Early in a Recession
To secure necessary cash before a recession hits, consider temporarily reducing contributions to your 401(k) and redirecting that cash to a brokerage or savings account.
Avoid making financial decisions based on fear, especially if your assets begin to depreciate in value. "A common error is making significant decisions based on emotions during stressful periods," Patterson cautions. Resist the urge to sell off assets at market lows or to hoard cash in a manner that yields no returns.
Having funds available to purchase assets that have plummeted in value due to a recession can be advantageous, as they may be available at more attractive prices, Mangaliman adds. "Recessions can present an opportunity to invest in companies that previously seemed overpriced," Mangaliman notes.
It is imperative not to be caught off guard by a recession. "Prepare in advance," Mangaliman advises, "or risk significant damage to both your investment portfolio and personal finances."
