A recession is coming!!
Yikes! When?
Not sure.
How severe?
Couldn’t tell ya.
How long will it last?
Your guess is as good as mine.
When you have an event that is inevitable, but the severity and timing are impossible to know, what do you do? You prepare, you don’t prognosticate.
Think about it, we prepare for all sorts of things Mother Nature throws our way and preparing for a recession is similar.
Today we will talk about what being prepared for a recession looks like.
Natural Disasters
Just this evening, my family and I were praying for a dear friend and their home that is in the danger zone of a current fire. My wife and I had dinner at their home just a few nights ago and now this. With little to no warning they were asked to evacuate.
I was recently catching up with an old friend from Texas and he recounted how just a few years back his entire house was destroyed in a tornado that tore through his hometown. He told me what picking-up-the-pieces looked like. The inventory sheet he had to prepare for the insurance company, trying to recollect all his belongings, pricing everything out, etc. It was quite an exhaustive process.
This conversation was a reminder to me of why a thorough review of one’s property and casualty insurance is so vital; a process I have been conducting quite regularly with clients recently. This is an area where preparation is key, a practice that one must be proactive about because being reactive is not an option.
You don’t predict the timing or severity of a natural disaster, you prepare for it.
Natural Market Disasters
Again, natural disasters are much like recessions. They make headlines, they cause damage, and they come with little warning.
The current news feed has been stirring up a lot of anxiety amongst investors, and understandably so. We are human, we despise uncertainty. The thought that a catastrophe could be lurking around the corner unsettles us.
Personally, I am convinced that investors can’t time markets consistently with any level of accuracy. I don’t have any confidence in managers or strategies that try to do so. This means that I am personally going to have to endure recessions and advise my clients along the way as well. It is these recessions, these tension points, they are the work, they are the pain needed to glean the benefits of compounding.
On the one hand, not having to be a soothsayer and not having to try to prognosticate on the unpredictable timing around market cycles is a relief. On the other hand, I needed to have a checklist of what it means to be “prepared” for a recession. That’s just how I am wired; I am a checklist guy.
So, here’s my recession preparedness checklist:
>> Sustainable & Growing Income
For someone in the accumulation phase of their investing life, recessions should be welcomed. An accumulator is dollar cost averaging into their investments and recessions create better entry points for investing. Better valuations make for opportunities to acquire more shares at discounted prices.
For those in the decumulation phase or withdrawal phase of their investment journey, recessions can cause a big problem. If you’ve crafted a financial plan that depends on selling assets to meet your withdrawal needs, all of a sudden you may be forced to sell assets at depressed prices to cover your lifestyle. For the accumulator, it meant acquiring more shares, for one that is in the distribution phase this means having to sell more shares. As we talked about a few weeks ago in the article titled Going Through Withdrawals, this sequence-of-returns risk can be detrimental to a financial plan.
So, part of preparing for a recession is to assure that your portfolio has sustainable and growing income that can be insulated from the impacts of a recession. Sound too good to be true? Might I suggest a book a friend of mine wrote on this very subject, The Case for Dividend Growth? Enjoy!
>> Sufficient Reserves
Most financial help DIY manuals start with the same advice – start and maintain an emergency fund. Why? Because life happens; emergencies happen.
You NEED sufficient reserves. What’s sufficient? Like most financial planning questions, the answer is, “it depends.” Here’s my advice though you should have a simple and logical explanation for how you came up with your reserve figure and it should be built to help you endure a worst-case scenario. Not Armageddon, but a 2008-type moment.
Just the other day, a client and I were talking about what this might look like for each of his rental properties. We concluded that sufficient reserves would cover 6-12 months of the mortgage payment plus enough to cover a large capital expenditure, like replacing the roof. Matching these reserve targets to each rental property seemed appropriate, they represented what my client and I believe to be “sufficient.”
>> Diversifying Assets
Post-March 2020 (the COVID moment) investors have been pretty sour about owning bonds. For some, the low yields and potential risk of rising rates made this asset class near uninvestable over the last few years.
I understand the distaste for elevated risk with little reward, but what concerned me is that this would cause folks to just pile into more stocks. If the classic retirement portfolio was 60% stocks and 40% bonds, what were these bond divorcees prepared to do with this 40%. Some were ready to load up on more stocks.
I’ve found myself reminding a lot of clients recently that Finance 101 taught us all about the benefits of diversification and diversification is still a key tenant of finance. The common mantra in finance these days is TINA (There Is No Alternative). Let me let you in on a little secret, there is an alternative, they are called alternatives.
Part of recession preparedness is owning different assets that will behave differently in varying market conditions. Being diversified doesn’t mean that you have to settle for lower returns (cash, treasuries, etc.) but rather that you are diversifying your sources of risk and return. Your portfolio need not be 100% publicly traded equities.
>> Recession Awareness
Knowledge is power and awareness brings comfort.
Have you ever noticed that a particular drive won’t seem as long the more you do it? The more familiar you are with different reference points along the way, the more your brain becomes comfortable with the timing of everything. The first time you take a road trip to visit family or your first commute to a new job may seem like it takes ages. Everything is new and unknown.
Investing veterans know this drive; they are familiar with market cycles. They know that there truly is nothing new under the sun. A dip is just a season, a trough is temporary, and two steps backward are often followed by five steps forward. They were not comfortable the first time they traveled this path, but familiarity has bred hope and peace.
Maybe you don’t have any market endurance experience. That’s ok, everyone has to start somewhere. A close second to experience is understanding history. Spend time looking back at the plethora of recessions in our financial history. Get familiar with the occurrences, the severity, and the recovery timelines. As difficult as it will be, try to imagine what those historical drawdowns would have felt like to endure. Let this digestion of market history help to build up your personal tolerance.
To be prepared, we want to try to remove the element of surprise. Surprises can lead us to do whacky things. This doesn’t mean we can’t be frustrated with a recession, emotions are allowed, I just don’t want us to be surprised. Remember, cycles are defined by things expanding and contracting or receding. This. Is. Normal.
>> A Decision Partner
Don’t go at this alone. One of the most underrated attributes of having a financial advisor is just the simple fact that you have someone to talk to. You have someone to collaborate with, you have someone to sort through difficult decisions with. You have permission to vent, you have permission to bounce ideas and theories off of someone who is (or should be) well versed in markets and financial planning. You have someone to remind you that trying to time markets is a fool’s errand 😊
Are you feeling uneasy? Call your advisor, text your advisor, email your advisor. In whatever form you prefer, connect with your decision partner and resource them. Financial planning is a team sport. Again, don’t go at this alone.
That’s It
Yup, that’s it.
Those are my notes. That’s my “be prepared” checklist.
Like I often say, you and I have something in common – neither of us knows what tomorrow has in store for us. Don’t be distracted by false prophets, focus on being prepared. Borrow my checklist and critique your own preparedness. Highlight areas for improvement and go be proactive.
I hope this content was helpful and of course, I will be back next week with more of my Thoughts On Money.
