Things are not looking good. Consumer confidence is falling like a rock. Eggs are $10.99/dozen at Safeway. Inflation is going up all over the place. The Atlanta Fed estimates GDP will turn negative in the first quarter. Unemployment will explode next month due to the purge of government workers. Businesses are holding off on hiring and expansion due to high uncertainty. The stock market is in a free fall and everyone’s retirement portfolio is thinning. The Tariff King is having the time of his life with trade wars, annexation plans, deportation, and missile strikes. Ordinary people are scared and we are battening down the hatches. Yes, all the pieces are here for a recession.
A recession isn’t a sure thing yet, but regular people should prepare for one. If you wait for a recession to hit, it will be too late. Here are 5 things to do before a recession hits.
1. Understand your cash flow
Cash flow is king when the going gets tough. You need to get intimate with your fixed cost, discretionary spending, and various sources of income. That way, you’ll know how to reduce your expenses and figure out the next move. Here is a more detailed post on understanding your cash flow. You need to know where your money is going every month.
2. Prepare for income reduction
The biggest problem in a recession is the loss of income. If your income remains stable, a recession isn’t a huge deal. You just keep working and continue to pay the bills. It’s a great time to invest because you can accumulate more shares for the same amount of money.
Unfortunately, businesses will cut back during a recession. Many workers will lose their jobs or work less hours. There is a high chance that your income will drop too. This is why you need to understand your cash flow so you can adjust as needed.
Can you continue to live the same lifestyle if your income is lower? For most families, the answer is no. Most households live paycheck to paycheck and have very little savings. Even if you have an emergency fund, how long will it last if you don’t have a job? You’ll be able to plan better if you understand your cash flow.
Anyway, everyone should prepare for an income reduction. No job is safe these days. Even government workers are getting laid off. Anyone is replaceable.
3. Beef up your emergency fund
Do you have an emergency fund? Will it last long enough while you find a new job? You need to beef up your emergency fund when a recession is looming.
Personally, I haven’t been very good with the emergency fund. In previous years, I usually keep about 2 months of expenses in cash. I invest almost all of our extra money because I want to put it to work. Our income streams have been solid, but that is changing. Mrs. RB40 probably will retire soon and her income will disappear. My FIRE income is also unstable. We will need to start drawing down our investment sooner than I thought. This is fine, but we need to beef up our liquidity. We need more cash when the economy is unstable.
The stock market is in turmoil. It is in correction already (decrease of 10%). A recession would cause the stock market to drop further. It would be a bad time to sell. This is why I’ve been beefing up our cash savings over the last few months. Now, we have about 1 year of annual expenses in cash and 1.5 years in I bonds. We’re ready for a recession.
4. Evaluate your risk tolerance and adjust your asset allocation
The stock market performed extremely well over the last 15 years. Many young investors have never lived through an extended recession. It looks like many people are already panicking by a 10% correction. They are asking if they should sell everything and move it to cash before the stock market crash further. This is a bad idea because most people don’t know when to jump back into the market. Timing the market is very difficult and most of us can’t do it optimally.
A better plan is to figure out your risk tolerance and set up an asset allocation that you can stick with. That way, you can weather a bear market. If you’re young, you need to keep investing. In 20 years, the stock market will be much higher than today. A stock market crash is just an opportunity to buy more shares.
However, your risk tolerance will be lower if you’re older. I’ll be 52 soon and I can’t stomach a 50% decrease in net worth. I also don’t have the money to invest when the market crashes. It’s all about capital preservation now. This is why I’m a lot more conservative than when I was young. Currently, about 60% of our portfolio is invested in the stock market. If the stock market drops 50% tomorrow, our net worth will decrease by about 22%. I can live with that and we can let it ride for 2.5 years.
Can you stay invested if the stock market drops 50% tomorrow? If not, you need to evaluate your risk tolerance and adjust your asset allocation accordingly.
5. Minimize news consumption
Once you made these preparations, you need to avoid the news. The chaos is too stressful. I’ve been losing sleep due to all the craziness in the news. If you can’t do anything about it, it’s better to minimize news consumption. The more you watch the news, the more pessimistic you’ll get about your investment. You will want to sell sell sell!
Unfortunately, things will get worse before they get better. I’ll take care of things I can control and ignore the rest. My mental health can’t handle this level of psychological assault.
Are you ready for a recession? What will you do if your income drops? Good luck everyone…
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Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.