Central banks’ efforts to save the global economy during the Covid-19 pandemic crisis have created an artificially strong economy, sky high inflation and asset price bubble. To fix these issues, central banks must now act quickly to reverse their simulative monetary and fiscal policies. However, so far they have been too slow to act.
From the market’s perspective, global central banks have lost their credibility in fighting inflation and therefore will likely cause an economic downturn in 2023. While today’s company earnings still look decent, investors have been selling stocks in anticipation of a mild recession 12 months from now.
We are officially in a bear market now.
If an economic downturn is coming soon, what should you do now? Here are the Top 5 things you should do now to prepare financially.
- Have a Plan B
In the US, we are starting to hear news of layoff (Tesla, Coinbase, Redfin, Compass, Netflix, Carvana, Peleton, Robinhood), hiring freeze (Facebook, Twitter) or companies having excess staff labor (Amazon, Walmart). If the capital market conditions continue to tighten and growth continues to slow, we believe more widespread layoff is possible in 2023.
What if you lose your job during a recession next year?
Do you have the cash reserve to pay all your bills and major expenses for 1-2 years while you look for another job?
You should always maintain a cash reserve fund for unforeseen situations during uncertain times. Ideally, this fund should be 12 to 24 months of your living expenses and be kept in a high-yield saving account.
If you have a major financial obligation in the short-term, you need to make sure to have the funds in cash and not invested in the bond or stock market.
2. Establish a budget and pay down your debt
Establish an income/expense budget to track how much you have coming in and going out each month. Get ready to downsize to a more frugal lifestyle by cutting expenses that are not necessary like dining out, new clothes or subscription that you never use.
Pay down any high interest rate credit card debt or transfer the balance to another card with a lower rate.
3. Evaluate your investment skills and track record
During Covid-19 pandemic period, many individual investors followed the media hype and speculated on many hot IPOs/SPACs of the month, high-flying technology stocks and cryptocurrencies that get clobbered in 2022.
Many individual investors have been wiped out because they thought stock trading is an easy way to make money. It turns out that following the crowd and buying the popular stocks is the easiest way to lose money.
Stock/Crypto trading is an ultra-competitive sport with lots of smart people dedicating to it as a full-time job. Amateur investors who follow the daily news and then trade these stocks/assets stand a very low chance of making money from the professionals.
Evaluate your investment and trading track record in the last 3-5 years. If you have lost a lot of money, you should stop picking your own investments and seek outside help for your retirement planning.
4. Review your retirement portfolio and make sure it is shock-proof
If the recent market volatility is causing you to lose sleep, then you need to re-evaluate your risk tolerance and re-balance the portfolio accordingly.
Given the risks of an economic downturn, it is very important that your portfolio be well diversified and shock-proof to various risks. Holding just stocks and bonds is no longer good enough in the current market, you should consider building a portfolio with a mix of cash, bond, commodities, energy, and real estate investments.
We have been investing conservatively since early 2022 by raising our cash allocation and focusing on value, high dividend and energy-related sectors in our portfolios. We are now looking to buy more stocks when everyone has lost interest in them and prices are getting more attractive everyday.
5. Have some cash ready to buy the financial market dip
History shows that recessions typically last 11 months. The next recession will be the third in the last 20 years. In every case, the price of financial assets will rebound after a few years.
Big profits are usually made by buying assets during a recession, not by buying hot IPO names when the economy feels exuberant.
We believe that the next 12 months will be a great time to deploy capital to buy solid assets at excellent prices. We think of a market crash as once-a-decade sales event.
The key is to have the guts and money to buy when everyone else is selling. An easier way is to dollar-cost average into your investment during a recession. You may not get the market timing exactly right but your purchase made during a downturn will become quite profitable after 2-3 years.
The Bottom Line
An economic downturn / bear market is a cleansing process that eliminates the weaker businesses and the less skillful investors. It is important not to get wiped out in a downturn. Smart investors take advantage of a bear market to buy the great financial assets at bargain prices.
Whoever survive a bear market will come out ahead and become the long term winners.