How to prepare for the next recession and make money in the process!

How to prepare for the next recession and make money in the process - small

Recessions come and go. In history there have been many recessions in the US. Since 1777 around 47 (1 every 6 years). In most recent years recessions have lasted for about 10-18 months. Obviously, the most vivid recession for millennials was the financial crisis in 2007-2008.

This recession lasted 18 months with the stock market dropping more than 50%. Combined with a peak unemployment rate of 10% (the highest since 1937), the ‘08 recession was vicious!

With over 10 years into the bull market the next recessions (at least historically) seems just around the corner. The question is: how to prepare for the next recession? There are several things you can do to limit the blow of an inevitable crisis and bear market. Let’s find out!

Never forget history

Stock market crashes are likely to occur suddenly and unexpectedly. It’s often a combination of different types of unanticipated negative news that drags the markets and economy in a crisis.

Below I have compiled a chart based on Dow Jones Industrial Average (DJIA) market data. It shows the Top 10 of the highest daily losses in percentages. Note that 2008 is in the Top 10 three times. The remaining days concern the period of the Great Depression and topped by Black Monday in 1987 with a one day loss of 20%. Ouch!

How to prepare for a recession - highest daily loss in %
Chart: Financial Chipmunk Source: Sizzlers and Fizzlers

The stock market crashed more than 50% in ’08 and more than 90% during the Great Depression. That makes you think twice before you invest in the stock market!

But rest assured, recessions have a historical duration of about 10-18 months. In 2008 the stock market drop of over 50% in about 18 months led to a bull market of over 10 years at the time of writing.

In 2009 the DJIA rose with 23% and in 2013 it rose with almost 30%. Two of the best years performance-wise in history. So if you think about the upcoming recession, don’t panic. Historically, over time market losses recuperated over a period of 22 months.

But what can you do to soften the financial blow of a recession? Turn to cash or gold? Here are several practical things you can do to prepare for the next recession.

1. Count your blessings and take some money off the table

This is the easiest thing you can do. Count your blessings (and returns) of the bull market of the past 10 years and be content. The “cash is trash” mantra is nonsense. Stocks and returns cannot buy you food or help you take care of your kids. Cash does.

But how much should you take off the table? That’s different for every situation. Some people shouldn’t take any money off the table, others should liquidate a large part of their portfolio and hold it in cash or treasury bills.

Here are some points you can consider determining how much cash you should hold:

  • How much savings do I have?
  • What is my monthly cost of living?
  • How many months does these savings cover?
  • Is it likely that I lose my job in a recession? How much value do I add to my company’s bottom-line?
  • How many dependents do I have? Young kids or kids attending university?
  • Do I have significant upcoming expenses that cannot be postponed? Health expenses, tuition fees, etc.

With an average recession duration of 10-18 months it’s important to at least cover 6 months of living expenses. This will be different for each person but it’s better to be safe than sorry.

2. Trim your debt level

Obviously, you already paid off any credit-card debts or personal loans. But in economic bad times you want to limit debt as much as possible. With stock markets down, unemployment rates rising and economic growth turning negative, you don’t want debt pushing you over the edge.

If you have a mortgage on your house or rental property, it makes sense to pay it off (partly). Lowering your debt level will give you the breathing room you need (or want) during the next recession.

Maybe it’s even smart to down-size in case you live in a home that costing you a significant amount of money every month while you don’t really need the space or luxury. Be smart and don’t live above your means!

There is not much flexibility in your mortgage payments. So it’s better to hope for the best but prepare for the worst.

3. Re-balance your investment portfolio

Now that you have arranged sufficient savings to hold on financially for the most part of the next recession and trimmed your debt, it’s time to re-balance your investment portfolio.

First, it’s important to create an overview of your portfolio. Second, look at your initial plan before you invested in the stock market and see if your portfolio is still a match. Perhaps your risk tolerance has changed or your personal situation has changed. Different job, kids, change in relationship, health situation, approaching or already in your retirement, etc.

These are all important elements to consider determining how much you want to decrease the riskiness of your investment portfolio. It’s not worth losing sleep over your investment portfolio.

Regardless of your risk tolerance if you want to prepare for a financial downturn you need to dial down your risk level. Equities get hit the hardest in a recession. Bonds the lowest.

A way to decrease risk is, for example, shift from individual growth stocks to blue-chip stocks. From blue-chip stocks to diversified index-funds. From junk bonds to corporate bonds. From corporate bonds to treasury bonds, etc.

There are many possibilities to dial down your risk level. Just make sure you feel comfortable with the riskiness of your portfolio. Shifting from stocks to bonds will deliver lower returns, but the peace of mind it can give you in times of a meltdown is priceless.

4. Invest in yourself

One of the best ways how to prepare for a recession is to invest in yourself. Period. By investing in yourself through training, reading books, learning new skills, etc. you make yourself fit for the economy of the future.

It’s important to stay up-to-date about new technologies like blockchain, machine learning and artificial intelligence. Knowledge about new technologies and developments will make it much harder to replace you by your current or future employer when the potential materializes.

Always make sure you add value to the company you work for. You can add more value by lifelong learning. This will not only increase the value of your labor but it increases fun on the job as well!

5. Keep an eye out for opportunities

An economic crisis comes suddenly and unexpectedly. But with that surprise comes significant opportunity. Markets will become distressed and sell at large discounts. Every investor is trying to liquidate their assets to limit losses, resulting in a race to the bottom.

When assets are sold far below intrinsic value you want to be a buyer. But to be a buyer you need cash. That’s why re-balancing your investment portfolio and having sufficient cash on hand is so important. As Warren Buffett has said many times: “be fearful when others are greedy, greedy when others are fearful.”.

Conclusion

No one knows when the next recession will happen. It can be in 2019, 2020 or even later. But one thing is certain. There will be another recession. Historically, the next recession will be sooner than later. Better be prepared!

To my readers: are you anticipating a recession? If so, how do you prepare for a recession?
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