Are you ready the next recession to wipe out half of your net worth? Can you survive a decimated stock market, the loss of your job, and sky-high interest rates?
Predicting economic recessions is like predicting earthquakes. It’s impossible to predict when the next Big One will hit. However, unless the fundamentals of local geology have changed, we should expect the past to follow the same pattern as the future. And the last time I checked, Southern California hasn’t turned into an island, and the Fed is still wreaking havoc with interest rates. The smart thing to do is to earthquake-proof your house — and your finances while you can.
The recession is overdue
Historically, bull markets have lasted an average of 30 months. We’re now at 100+. During the average recession, the market falls 35%, but given the duration of the current run-up, and the malinvestment caused by the lowest interest rates in history, 50% or more is not unlikely.
The worst that could happen
Here are things that could happen when the Big One hits:
- Your stocks will lose half their value
- You will lose your job (or customers, if you run a business)
- Loans will become prohibitively expensive
While all these things probably won’t happen to you, everyone should perform a stress-test. If you were to lose your job or business for an extended time, would your family be OK? What’s your contingency plan?
If your business model or job depends on the availability of easy money, you will need to scramble to find a new career. Mortgages, student loans, and auto loans are in an unprecedented 12-trillion plus bubble. I would not want to go into these fields right now.
How to prepare
This post by Richard Reis contains pretty much everything you need to know
- Don’t hold an all-stock portfolio. When your portfolio is down 50%, you need to think about buying, not selling. That’s hard to do when you need the cash ASAP. Bonds are the most cost-effective way to protect yourself. In a recession, keep your stocks, and sell bonds first. If you have minimal liabilities and a secure job, this percentage can be quite low.
- Save money while you can. Now is the time to build up your savings. Use your salary, bonuses, etc to grow your portfolio. Saving may be much harder when the crisis hits.
- Diversify into non-market assets. Hold some of your net worth in assets which have minimal correlation with markets – gold, property, Bitcoin, etc.
- Build an emergency fund. My emergency fund is held in corporate and government bonds earning about 4.4%. With my brokerage debit card, I can sell them and get cash in my hands within a business day. Because I have no debts of any kind and few financial obligations, it’s only enough to pay for a few months food and rent.
Bitcoin won’t save you
Some people have analyzed the lack of correlation between the traditional and cryptocurrency markets and concluded that Bitcoin can hedge you from an economic meltdown. I don’t agree with this. There is no reason to think that short-term market fluctuations should be related to the Bitcoin price, but long term, I expect a strong correlation between traditional and crypto markets. One of the biggest drivers of the Bitcoin price are low worldwide interest rates, leading individual investors to bet on Bitcoin. This works as long as people have money to spare. During a recession, people will be scrambling to get money to keep their businesses, homes, and cars afloat. Because crypto markets are still a tiny share of the total economy, they will be quickly drained of most of their value. Only a minority of the value of Bitcoin is regularly traded, so it would not take much to crash the price to a fraction of its value
What should I do in a recession?
- Buy everything! The best time to buy anything – stocks, houses, employees to grow your company, etc, is when prices are depressed. If you have the cash, the depths of a recession are the best time to buy it.
- Don’t buy anything! Waiting for a recession to start saving money is a terrible idea, but that describes you, you should minimize your spending while you still have an income to build an emergency fund.
- Maximize your savings rate. I lost over 60% of my portfolio in 2008-2009 recession, but by aggressively investing much of the salary in 2009, I made it all back and set myself up for a lifetime of financial security.
- Don’t panic! While everyone else was selling in 2008-2009, I started scrounging up money to invest. I started buying in January 2009 – and saw my portfolio go down another 15%. But I held on, and made a 58% return that year.