Are You Ready for Another Recession
Dear Rich Lifer,
Although the U.S. economy continues to grow and add jobs, talk of the dreaded “R” word is on the rise due to a number of worrying signs.
Yes, I’m talking about a “Recession”.
Between the ongoing trade war with China, an inverted yield curve, and the Federal Reserve lowering short-term borrowing costs, investors are starting to get spooked.
A question I get asked a lot is what should retirees do with their money when a recession is looming?
When the market crashed in 2008, an estimated $2.4 trillion disappeared almost overnight from Americans’ 401(k)s and IRAs.
The fear of losing everything to another recession is sending a lot of investors running for the hills.
However, there are steps you can take today to minimize losses during a recession, no matter your age or financial situation.
Here’s a checklist you can follow so that your investments and savings can weather any financial storm.
1. Start tracking your cash flow.
Step one in preparing for a recession is knowing where you stand. The best way to figure this out is by calculating your cash flow, or how much money you have coming in versus going out.
Knowing what your fixed and variable costs are each month as well as where your income is coming from will relieve some of the uncertainty should there be an economic downturn.
If you’re employed, there’s a high chance that you might get laid off during a recession, so you’ll want to know exactly how long your savings will last.
An easy way to begin tracking cash flow is with free mobile apps, like Mint or Personal Capital. You simply connect your bank accounts to these apps and the software tracks your transactions and categorizes your spending.
This way you know where your money is going each month and you can start setting budget goals or identifying expenses that can easily be cut in the future.
2. Top up your emergency fund.
Your best defense against economic hardship will be a well-funded emergency fund. Rather than rack up high-interest debt, you can tap your savings to cover basic living expenses.
As a general rule-of-thumb, I recommend building an emergency fund of 3-6 months worth of expenses. With talk of a nearing recession, however, it’s best to err on the conservative side.
The reason why an emergency fund is critical is because you’ll need liquid money to keep paying your bills. If you or your spouse lose your job, an emergency fund will come in handy to keep you afloat.
If you’re retired, you won’t have to worry about getting laid off, but you’ll still need an adequate amount of accessible cash in case your retirement accounts or pension take a hit.
3. Pay off outstanding debt.
With talk of a recession happening in the next year or so, it’s a good time to start aggressively paying down any bad debts you owe.
Should a recession strike, you’ll want your income going toward monthly living expenses and not paying the bank.
Plus, if you miss too many payments you could end up wrecking your credit score, which will make your life even more challenging when the economy recovers.
Also, whatever you do, don’t dip into your 401(k) to pay off debt, especially if you’re not yet retired. Start with high-interest debt first, like credit cards and build debt payments directly into your budget so you don’t forget.
4. Rebalance your investment portfolio.
Once you’ve taken care of your emergency fund and paid down any outstanding debts, it’s time to review your investments.
If you’re already retired or close to retirement, you’ll want to mitigate as much risk as possible but still maintain enough growth in your portfolio to pay for living expenses and outpace inflation.
Traditional wisdom of maintaining a 60/40 mix of stocks and bonds is no longer enough diversification.
The reason being that retirees are now living longer, which means your portfolio needs more room for growth. Look to diversify your portfolio to include a wide range of asset classes, like foreign stocks and bonds, this will put you in a better position to endure a downturn.
5. Manage your 401(k) wisely
If times get really tough, it can be tempting to want to sell or make significant alterations to your 401(k). My advice: don’t touch it.
Most likely, your 401(k) is part of your long-term financial plan, which means economic downturns are part of the deal. You don’t want to jeopardize any long-term gains by panic-selling the moment markets start dropping.
Lastly, if you’re not already maxing out your 401(k) contributions or taking advantage of any employer-match programs, make sure you do. That’s your money to keep.
Finally, understand that recessions are a normal part of the economy. They’re cyclical in nature and notoriously hard to predict. Control what you can by heeding the warning signs and preparing best you can.
To a richer life,
This story originally appeared in the Daily Reckoning
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