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.

Cash is king they say. This holds true especially during a recession.

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.

homeless
No one wants to end-up living on the street, but it’s that emotion — that fear of running out of money that keeps us from investing at the right times.

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]

33 thoughts on “How To Prepare For The Next Recession

  • March 23, 2019 at 9:18 AM
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    Mr. Tako –

    Great article and always well-timed. We have more cash now, due to the market providing little room for opportunities. Working your butt off in everything you do, will keep that mentality going – whether that’s working for a company or for your side hustles, continue to truly care and put in the work.

    Further, cut down the expenses and invest. Get those additional cash flows from assets is key! Loving it and all should strive to do this, as much and as often as possible.

    -Lanny

    Reply
    • March 25, 2019 at 2:57 PM
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      Thanks Lanny! Totally agree! Put in the work and you’ll see results.

      Reply
  • March 23, 2019 at 12:09 PM
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    Good information, Mr. Tako! Hopefully, people have already been started preparing.

    I like the last one the best. The more income sources you have across various markets, the less of a chance of you have of getting destroyed when the economy turns. 😉

    — Jim

    Reply
    • March 25, 2019 at 2:58 PM
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      Indeed, I like the last one too! Having more than one income source has saved my bacon multiple times!

      Reply
  • March 23, 2019 at 12:33 PM
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    Just the kind of information we should all be reading and re-reading. And for anyone considering selling their assets during a recession, they should remember the quote by Warren Buffett: “Be Fearful when others are greedy and greedy when others are fearful”.

    Reply
  • March 23, 2019 at 4:11 PM
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    Typically, recessions have historically been short in duration (less than 1 year) compared to the expansion periods. Most people who self-identify as FIRE will be able to ride out the recession.

    Bear markets (which is are distinct from recessions) are also short in duration compared to bull markets but depending on your net worth & investments, a typical bear market will hurt more than a typical recession…at least it would/does for me.

    Reply
  • March 23, 2019 at 5:56 PM
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    Thank you for your post. Good reminder for us to start preparing now rather than when it’s already too late. I was in college in the last recession and didn’t have to think through all this. Definitely working hard on building side hustles to cope with the possibility of a recession coming.

    Reply
  • March 23, 2019 at 9:20 PM
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    Great stuff Mr. Tako. Good lessons for everyone regardless whether we are in recession or not. Holding a bit more cash and look for opportunities is always a good idea.

    Reply
  • March 23, 2019 at 9:23 PM
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    Why keep such a large cash pile around when all it is is basically insurance.

    Good ‘ol Uncle Sam has provided safety nets for people who lose their jobs and have low incomes. Need food? It’s called SNAP. Need help with the power bill or gas bill? Energy Assistance. Need health insurance? Obama care. Need to pay the mortgage? How about mortgage payment assistance.

    Having large amounts of cash will disqualify you from all of that. A small amount is fine, but better to keep it working for you and not market time. Uncle Sam has your back if times get rough.

    Reply
    • March 25, 2019 at 8:27 AM
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      I’m pretty sure they treat assets in investment accounts as cash in the bank.
      If you have a six-figure stock portfolio, you won’t get SNAP.
      I’m not 100% sure about the other ones.
      Obama care only looks at income, not assets.

      Reply
    • March 25, 2019 at 2:59 PM
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      Let’s just keep things civil here and say that opinions on these matters differ. 😉

      Reply
    • March 25, 2019 at 3:00 PM
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      Thank you Budget Epicurean! Always good to know when people like your stuff! 🙂

      Reply
  • March 24, 2019 at 7:22 AM
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    It is always good to read reminders to take advantage of the good times to prepare for possible bad times! I rarely think about getting laid off or not having my main job but it could absolutely happen at any time! This is a scary thought but having a few income streams make me feel a bit more confident!

    Reply
    • March 25, 2019 at 3:01 PM
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      Yep, it having multiple income streams helps me feel more comfortable knowing that a recession is coming.

      Reply
  • March 24, 2019 at 10:35 AM
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    Sound counsel. Our lack of debt and cash cushion has a cost, but there’s a big asymmetry between the down and up scenarios. I’ll take a little less return and leverage for protection on the downside. Let’s hope a lot of folks who have never experienced a recession don’t get burned!

    Reply
    • March 25, 2019 at 3:02 PM
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      We can only hope for the best. As I’ve said before, my crystal ball is always cloudy! 😉

      Reply
  • March 24, 2019 at 10:00 PM
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    I am heavier in cash right now than normal. I get a lot of criticism because being more heavy cash has me chasing yield in other areas which is difficult in this environment and takes quite a bit of effort. Interesting post and it will be interesting to see if the yield curve inversion becomes something. Another solid post my eight legged fellow blogger 😉

    Also, that pic made me pause for quite awhile. Somewhat intrepid and somewhat uncomfortable to put a pic with your pants down out for all to see. Very bold

    Reply
    • March 25, 2019 at 3:03 PM
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      Not my pants down, just a royalty free image off the internet.

      Reply
  • March 25, 2019 at 8:37 AM
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    This is exactly why I got into real estate investing. After the dot.com bust of 2000-2002, I started looking at alternatives to just stock investing. My rental properties pay the same no matter how the economy is doing. Actually, mine have done better in a downturn. It seems like more people are looking to rent. I know if it is bad enough in an area that a recession can cause rents to decrease, but that is just a reason to make sure a property has a good cash flow before buying.

    Reply
    • March 25, 2019 at 3:04 PM
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      After 2008, I think homeownership definitely took a dip. I can’t recall where I saw those statistics however.

      Regardless, rental income can definitely provide good cash flow during recessions. 🙂

      Reply
  • March 25, 2019 at 9:53 AM
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    Excellent advise. I’m waiting for a recession to hit. Do you have a crystal ball? Do you think it will be 2019?

    Reply
    • March 25, 2019 at 3:05 PM
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      My crystal ball is permanently cloudy. I have no guess as to when it will happen (unfortunately).

      Reply
  • March 25, 2019 at 12:11 PM
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    Great Post. This is one of the main reasons I decided getting all my debts paid off would be best to do ASAP. Anytime anyone asks why I’m doing all this I keep replying with “I want to recession proof myself”. I have enough seniority at my company that with any layoff I will be set for 8 months, basing that on severance they offered during the last recession. And if I have everything but the house paid off I can stretch that money for 18 if need be.

    Reply
    • March 25, 2019 at 3:06 PM
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      There’s an old saying — “Make hay while the sun shines”. Well, we’re in the 11th hour of sunshine. It makes a person wonder when folks are going to start paying off debts if they haven’t already.

      Best of luck to you in the next recession!

      Reply
  • March 25, 2019 at 2:06 PM
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    Since the bond yield inversed, my husband did just put another 30k into short term treasury bonds. I hate to be caught with our pants down. I’m glad we unloaded our old Airbnb rental property because it would have been a nuisance to hold on to. Turns out the person who got it from us put it on the market for 3 months now — and it ain’t moving! That would have been us!!!

    Reply
  • March 25, 2019 at 10:06 PM
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    Also, it might be a good time to review your asset allocation. Shifting money away from stocks to fixed income might make sense if you are preparing for a recession or to go to T-Bill or gold.

    If you want equity exposure, maybe move from tech to defensive stocks. The tech section is one to get hit first in a recession because companies tend to reduce IT spending first when business isn’t doing well.

    I think if you already have a chuck of wealth invested, then the other point is to be mentally prepared for a recession. Assets prices will fall. Don’t panic. Read up on past recessions and the best approach to investing through them. Don’t sell when prices are low and, mentally, can’t get back in when prices recover or go even higher.

    Reply
  • March 27, 2019 at 4:25 AM
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    Great Post Mr. Tako! In preparation for a recession I’m trying to reduce the amount I look at my portfolio. It’s more difficult that I had planned, but I know it’ll help if the markets start to tumble and I just put my temporary losses out of my mind and check back in every 6 months.

    So far I’ve moved from an every day check, to every two days. Baby steps.

    Reply
    • March 28, 2019 at 9:50 AM
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      Good job! If you’re not planning on buying anything, once a week (or less) should be fine.

      Reply
  • May 5, 2019 at 12:10 AM
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    Hi Mr. Tako,

    Great post. I use to work with a guy back in 2013 that said that he would not open a position in the market because he would expect the next bear market. I guess he is still waiting…

    Overall I believe that I’m prepared for the next recession. No debt, cash on saving accounts, and trying to cut expenses. Have another source of income besides the dividend would be a plus for us, but so far I have not worked on it. I use to say that if I survive through the next recession the FI forecast will be ok.

    All the best.

    Cheers!

    Reply

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