How To Prepare For The Next Recession

It’s been roughly 10 years since the last recession in the U.S.  Historically, that’s a long time to go without a recession.  Some people say its been too long.

On Friday, the US treasury yield curve inverted, which is considered a leading indicator of a recession.  Could an economic slump be right around the corner?

Your guess is as good as mine, because I have no ability to predict the future.  However, when economic indicators start pointing negative, I think it’s a really good idea to make sure your finances are prepared for when the recession does happen.

The absolute worse thing that can happen is you fail to prepare — a recession hits you when have your pants down (financially, not literally).  You could lose your job and the bank could foreclose on your home.  You might start missing bill payments and your credit could suffer.  Even worse, you could be forced to sell assets like stocks and bonds just to pay the bills.

It’s a terrible situation to find oneself in, and it can dramatically hurt your chances of reaching financial independence.

The moral of the story here is — Don’t get caught with your pants down.  Prepare for the storm ahead of time, not when the storm actually hits.

So, how do we prepare for the next recession?

1. Work Hard Today

Today we sit atop an economic boom that is a decade in the making.  It’s fairly safe to say that anyone who wants to be employed has already found employment.  When the recession hits however, that’s when the layoffs start.

The “non-essential” employees always get the pink-slip first, so it makes sense to become “essential” right now, before the recession hits.  This mean working really hard to be the best possible employee you can.  Show up early, go home late.  Be friendly and easy to work with.  Volunteer for work you don’t have to do, and do your work with excellence and diligence.

If you prove yourself to be a super employee right now, when the layoffs start you might find yourself missing from the layoff list.  This means you get to keep your job when others get sent home.  Your paycheck keeps coming in, and you get to keep compounding money for that eventual retirement.

This strategy isn’t 100% foolproof however — even good employees can find themselves fired when tough economic conditions require drastic action.

I once worked for a division of a much larger corporation where this actually happened.  Before the 2008 Great Recession, the division had been profitable for 20 years, and we expected similar profitability into the future too.  When the recession hit however, the larger corporation decided to close the division I worked at (in an effort to conserve resources).  All 150 employees were let go.  Myself included.

This is a pretty drastic example of the difficult decisions corporations have to make during recessions.  It does happen.  There was nothing working harder could have done in a situation like this — good employees and bad employees alike were let go.

Most of the time though, being a model employee before a recession hits is going to help your chances of staying employed when the recession finally happens.

2.  Keep Plenty Of Cash On Hand

Jobs have more uncertainty today than ever before, so it makes a lot of sense to keep plenty of cash on-hand to deal with potential income disruption.  In other words, don’t live paycheck to paycheck.

This is very true during recessions as well.  Know how much you spend, and then keep a 6-month to 12-month cash balance somewhere you can easily access it.

Why 6 to 12 months of cash?  Because during a recession it can take that long to find a new job.  Trust me, I’ve been there.  If it wasn’t for cash savings I would have been a homeless person.  The bills keep coming in, and loan payments still need to be made.  Any unemployment benefits you might have eventually run out.  Then you’re on your own.

During the 2001 and 2008 recessions, I was extremely thankful I kept a decent “emergency fund” around.  Eventually I did find a job, but during both recessions I had several months where I had nothing but my savings to eat and pay the bills.

This taught me a very important lesson in life — Never run out of cash.  Today, I keep a very large cash pile.

3.  Get Your Debts Under Control

It also makes sense to use the economic boom period before a recession to pay-off any high-interest debts you might have.  Credit card balances and car loans need to get to zero.  Likewise, any other high-interest debts need to be paid-off quickly.

The only exceptions to this rule are low interest loans, like a mortgage.  Usually during a recession the Federal Reserve lowers interest rates, and this typically means mortgage interest rates also drop.  If you have good credit, it’s very possible that you can refinance a mortgage and lower your monthly payment during a recession.

I did this during the last recession and it free’d up almost $300 a month in our budget.  That extra cash was then invested when the stock market was near its lowest point, providing much higher returns than the 3.5% interest we pay on our mortgage.

In fact, many of the stocks and ETFs I invested in at the time had higher yields than 3.5%.  It was a real win for our cash-flow.

4. Tighten Your Belt

While this one only made it to #4, it certainly feels like it should be higher on the list.  Tightening your belt, otherwise known as “lowering your expenses” is super important during a recession — Not only because your job income could end at any time, but also because any extra savings you can manage to invest when the market is near its lows will see extremely good returns when the recession finally ends.

In 2010 for example, we saved about 70% of our income and then invested that.  During this time we purchased loads of preferred shares selling at rock bottom prices… and yielding anywhere from 8 to 15%. Those preferred shares eventually doubled as the economy improved.  The cash flow they provided was excellent too.

It was totally worth it for us to put off extra spending and save just a little more.

Need some ideas on where to cut unnecessary expenses out of your budget?  Here’s a few that I’ve used to good effect:

• Cook at home.  You can easily cut your monthly food spending in half by doing all of your cooking at home.
• Cut entertainment spending.  I just read that the average U.S. home has 3 streaming content subscriptions now.  Really?  Cut this down to zero and go to the library instead.
• Don’t drink.  Alcohol is expensive, and probably not all that healthy for you anyway.
• Don’t drive.  Walk, take public transportation, or ride a bike.  It’s way cheaper than driving everywhere.
• Cut premium data communication plans.  You probably don’t need the fastest cable internet plan or that cell-phone plan with the large data caps.  Call your provider and dial back your plans to cheaper options with slower speeds and lower data caps.  You probably won’t even notice the change.
• Don’t go shopping.  I’m serious!  If you don’t go shopping you won’t be tempted to spend on things you don’t need!
• Turn the heat down and turn off extra lights.  All of us can do a better job at living more efficiently.  We just need to try a little harder to not waste energy.  Yes, this might mean throwing on a sweater or a pair of slippers to be comfortable.

5.  Put Your Cash To Work

Unemployment can put fear into the heart of anyone in the middle of the recession.  Nobody wants to end up homeless on the street with nothing to eat.

This is partly why stocks tend to fall during recessions — people conserve cash because of fear.  They don’t invest when afraid.

Want my advice?  Don’t let the fear of running out of money control you.  Invest when the mathematics are right, not when your emotions say it’s the right time to invest.  Your emotions will tell you to invest after the economy has already gotten better… and you’ll have missed out on the best time to invest.  You want to invest when stocks are at their lowest, when fear is the predominant emotion.

How do you do invest when everyone around you is scared and nobody is investing?  Have a big fat cash pile that won’t run out anytime soon, and then make quality low-risk investments.

It’s not easy, but it’s the best advice I can give.  Having a big cash pile certainly helps me sleep well at night.

6.  Create “Other” Income Sources

It almost goes without saying that if you have access to income sources besides your primary job (such as a side-hustle), you should definitely maintain and develop those “extra” income sources.

Side-hustles are the most common form of “extra” income generation.  Maybe it’s dog walking, mowing lawns, or flipping goods on Ebay — whatever the case, every little bit of extra income helps.  If you know how to generate extra income in your spare time — definitely do it!

In the Tako families case, we tend to own passive income assets that generated extra cash for us.  This has been enormously helpful during recessions when job loss impacted us.

While some people fear dividend cuts during recessions, in my experience it hasn’t been that big of a deal.  For a well diversified portfolio it won’t have a huge impact.  It does happen however.  Be aware.

For a more stable passive income source, bonds and preferred stocks tend to keep paying through recessions (primarily because there are penalties if payments are missed).  Those can be considered fairly stable passive income sources.

Rental real estate is another ‘side hustle’ that’s very popular in certain crowds.  It can be an incredible wealth creator under the right conditions — It’s one of the classic side-hustles for building wealth outside your job or the stock market.  There’s plenty of books on running rentals on Amazon.  That said, it’s not easy.  Dealing with tenants, collecting rent, marketing your property, and performing maintenance aren’t for everybody.  Definitely do your research first.

Personally, I lack the time to personally manage rental properties.  I prefer REITs over direct rental ownership for my real estate holdings, although there are certainly still risks with owning real estate in this manner.  (If you are looking for a book on REIT investing, The Intelligent REIT Investor comes highly regarded.)

Final Thoughts

Compared to “boom times” when jobs and cash are plentiful, recessions can be pretty scary times.  Stocks tend to fall, and people lose jobs left and right.  Income dries up, and fear can shell-shock any investor.

Don’t give in to the fear.  There’s no reason to be afraid — With a little preparation you can set yourself up to be prepared for whatever the recession happens to throw your way.  The loss of your major income source is not going to be the end of the world.  You’ll pick yourself up and muddle onward.  Smart investors will cultivate and develop multiple sources of income, hold a cash buffer, and then invest when the math is right.

Then, one day the sun will shine a little brighter and the stock market will be in a better mood.  When that day finally comes, you’ll know how much it pays to be prepared.

[Image Credit: Flickr1, Flickr2]