What Issues Should I Consider During a Recession or Market Downturn?

The coronavirus pandemic began as a public health concern, but it didn’t take much time before the spreading outbreak began to raise troubling economic questions and talk of a looming recession.

Recessions are part of the economic cycle when growth stops and the economy starts to shrink. They are natural and inevitable, but it’s difficult to predict when they will occur. Some recessions tend to be mild, with declining economic activity and rising unemployment, but the economy quickly recovers. Other recessions, such as the 18-month 2007-to-2009 downturn sparked by the financial crisis and often referred to as the Great Recession, last much longer and have a much greater impact on the financial lives of millions of people. Those larger downturns can be and have been followed by more than a decade of economic growth.

Although you can’t control what happens with the wider economy, there are steps you can take to help you better prepare your finances and make it through a recession a bit easier.

CASH FLOW

A good first step is to go through your monthly expenses and identify expenses that are a necessity and expenses that are discretionary. Discretionary expenses are the things you pay for that you really don’t need and can easily live without, and are most likely the things you can eliminate either now or in the future. Typically it’s recommend to spend no more than 30 percent of your net income (earnings after taxes) on discretionary expenses. To ensure you’re living within your means and maintain control of your spending, it’s a good idea to create a monthly budget or spending plan. Your spending plan needs to include all of your necessities. Paying your rent or mortgage, car payment and car insurance, food, and utilities are all examples essential expenses. However, expenses such as dining out, vacations, going to the movies, even your cable or satellite TV service, are all types of discretionary spending.

Once you’ve created the list of all of your expenses, compare the total of those expenses to how much cash you have coming in each month. Are you overspending? Do you have money left over? If you have money left over, are you comfortable with the amount? Whatever your answer is to these questions, evaluate the list of expenses you’ve created and see if there’s anything that you could or should cut out to help you save more.

As you look at your list, do you think you might be overpaying for anything? Does your cell phone provider offer newer, lower rate plans? Can you order your contact lenses from a different source that has a lower price?

If after trimming your expenses you find yourself spending more than you have coming in each month, you could look at an additional source of income. These days a lot of people accomplish this via driving for Uber or Lyft, delivering for Amazon or Postmates, or other similar type of work. They are flexible and allow you to work when you’re able to.

EMERGENCY FUND

The loss of a job can make it difficult to pay for day-to-day expenses. To cope with the potential loss of a job, it is best to have an emergency fund that can make it possible for you to still pay for your necessities while you search for new work. It is best to have 3-6 months of living expenses accessible for any situation that would require it. Having an emergency fund could keep you from realizing at some point that you don’t have enough money to pay for food, medications, your car, or your rent or mortgage.

Even if you have debt that you’re trying to pay off, it’s very important to prioritize saving. One method would be to first build an emergency fund with one month of living expenses. Once you have that continue paying off debt while at the same time also continuing to build up the emergency fund. Once you have 3-6 months of living expenses in your emergency fund you can return your focus to paying off your debt, while also having the peace of mind that you’re prepared in the event of an emergency that prevents you from collecting a regular paycheck.

EMPLOYMENT

If your field of employment is vulnerable to a recession but you haven’t yet been laid off, keep your resume updated and be diligent about networking. As discussed above, take a look at your spending plan for ways to reduce expenses and make sure your emergency fund will cover the appropriate number of months (usually 3-6 months).

If you’ve lost employment, apply for unemployment insurance benefits and explore other financial resources to assist you. If your loss of employment is directly related to the current coronavirus pandemic, you can see the previous article ?

DISTRIBUTIONS FROM INVESTMENT OR RETIREMENT ACCOUNTS

If you’re near retirement or already retired, it’s a good idea to evaluate your minimum distributions. The CARES Act enabled any taxpayer with an Required Minimum Distribution (RMD) due in 2020 from a defined-contribution retirement plan, including a 401(k) or 403(b) plan, or an IRA, to skip those RMDs this year. This includes anyone who would have had to take the first RMD by April 1, 2020.

DEBT

Economic downturns often lead to widespread job loss. If you have any concerns about your job security, as long as you have an appropriate emergency fund in place and accessible, it’s highly recommended to pay down outstanding debt. Doing so will give you some breathing room in your budget and help bring you more peace of mind. Prioritize the high interest rate credit card debt, then turn to other types of loans, such as mortgages and car loans. Student loans, however, have more favorable provisions, which makes paying them off less of an urgency.

IS IT TIME TO REBALANCE YOUR INVESTMENT OR RETIREMENT ACCOUNTS?

A good strategy for weathering market downturns is to make sure your investments are in line with your long-term goals and risk tolerance. A balanced and broadly diversified portfolio offers the potential to benefit from growth periods while being more resilient during periods of volatility compared to non-diversified portfolios. It is important to regularly review your portfolio’s overall asset allocation and rebalance to the original targets. This will help maintain the original and appropriate level of diversification for your risk tolerance. Diversification won’t eliminate the risk of loss, but it does spread the risk across various asset classes.

HAVE YOU MADE CONTRIBUTIONS TO A TRADITIONAL IRA OR ROTH IRA?

If the market is currently down, and you haven’t made your yearly contributions to your Traditional IRA or Roth IRA, now is a great time to make those investments and benefit from the lower priced investments on the market.

DON’T TRY TO TIME THE MARKET

Recessions and market downturns are typically accompanied by volatile stock market activity, with large daily swings in gains and losses. When you see that happening, it may be tempting to shift your portfolio into cash. Such moves can backfire. The stock market may have roller-coaster moments, but over long periods of time the downturns are overshadowed by longer periods of sustained growth. Don’t allow yourself to have emotion-driven reactions like selling during market dips and possibly missing the eventual uptick. Some of the strongest returns can occur during the late stages of an economic cycle or immediately after a market bottom. In fact, if you look at the five worst market declines since the 1930s, according to the Standard & Poor’s 500 Index, returns in the first year after the lows have averaged 70.95% (excluding dividends and/or distributions). Also, the average investment value has more than doubled over the five years after those market lows. Of course, past results are not a guarantee of future returns. The general recommendation is to stick with the investments you’ve selected for your time horizon.

FAVOR QUALITY INVESTMENTS

If you’re considering investing more money during a market downturn you should seek out investments that may help increase your long-term chances of success. Invest in mutual funds with a history of strong performance in both bull and bear markets. If your goal is growth, aim for companies with strong balance sheets, good management, and proven long-term track records. If you want a more conservative approach, buying shares of a growth-and-income fund that invests in dividend-paying stocks may offer some return potential when stock prices are declining. Another area to invest is bond funds. U.S. bond market returns, as measured by the Bloomberg Barclays U.S. Aggregate Index, remained flat or positive during five out of the past six market corrections. Investing in some bond funds may help provide your portfolio with some stability that can help lessen the impact of stock market volatility during market downturns and recessions.

REMEMBER YOUR APPETITE FOR RISK

Investing in the stock market is inherently risky. The ability to remain invested during market downturns and through the eventual recovery is what will make for winning long-term returns. If you know how much volatility you’re willing to handle in exchange for higher potential returns, then you can build and maintain an investment portfolio that satisfies your risk profile and realistic return expectations.

GET HELP WHEN YOU NEED IT

There are a lot of nuances to finance and investing. It can be confusing and stressful. The good thing is you don’t have to go it alone.

The accompanying checklist helps you identify the issues you should be looking at and addressing. It’s a free immediate download if you fill out the form below.

Escient Financial is here to help you find the right investments for you and your personal and financial situation to make it possible to reach your goals. If you’d like to find out how Escient Financial can work with you to navigate through the current market, feel free to...