A recession is undoubtedly going to occur in 2023. Leading indicators, economic indicators that lead the overall economy, are signaling a 98% probability that a recession will start within 3-4 months.
This has many people worried about their financial stability. While we cannot control the economy or the markets, there are steps we can take to prepare ourselves and potentially even profit during a recession.
1. Emergency Fund
The first step is to have an emergency fund. This is important at all times but even more so leading up to a recession. The standard rule of thumb is to set aside 3-6 months of living expenses.
However, if your income is at risk during a recession, it is a good idea to add to that cushion and aim to have six or more months of expenses covered. This way, if you do lose your job, you will have a safety net to fall back on. An emergency fund will also give you peace of mind, easing your recession anxiety.
2. Pay Off High-Interest Debt
High-interest debt is debt with an interest rate above ~6% (credit cards, personal loans, student loans, etc.). In my opinion, you should strive to avoid all types of high-interest debt, regardless of the economic climate. However, student loans can be the exception here. We understand that not having student loans in 2023, especially if you are a recent graduate, can be unrealistic.
Nonetheless, if you have high-interest debt, it is best to pay it off now. Aggressively. This will be less of a burden if you lose your job or experience a loss of cash flow.
3. Review Your Budget
The third step is to tighten up the ol’ belt. Even if it’s not your favorite activity, reviewing your budget can be extremely helpful when preparing for a recession.
The goal here is to improve your positive cash flow. The easy answer is to make more money (if only we were all so lucky to be in such a position). If you cannot increase your income easily (and quickly), you are left with one option – decrease your expenses.
Take a look at what you spend your money on by putting together a budget – a plan for your monthly income and expenses.
You can’t cut your expenses if you don’t know what or how much they are. How much do you spend on restaurants every month? What do your Amazon expenses look like? Once you find these monthly figures, you can then cut back on the unnecessary stuff.
4. Job Security
This one is a bit more challenging to explain and implement as each job and sector is unique. But if there is any way to reaffirm or improve your job security, it’s worth doing. This may include getting an extra credential or taking on a more significant project at work.
If you’re worried about losing your job, it’s a good idea to take those extra steps to make yourself indispensable. Take on those extra job functions. Start working towards that credential. Make yourself critical at your firm, not expendable.
You probably already know that it is crucial to diversify your investments – don’t put all of your eggs in one basket, no matter how nice the basket may look.
By spreading your investments across different assets (sectors, countries, asset types, etc.), you’ll be less likely to lose all of your money if one investment performs poorly.
Weird things can happen during a recession, and no two recessions behave similarly. In the tech bubble burst (2000-2002), tech companies were hit particularly hard, and the unemployment rate was mainly localized in the Bay Area. During the Great Financial Crisis (2008-2009), financial services, construction, and real estate were especially vulnerable. During the COVID Recession, leisure and hospitality were hit the hardest.
Which sectors will be impacted the most during the 2023 recession? We don’t know for sure, but leisure and hospitality, tech, and construction look vulnerable, but this is not guaranteed.
It is also essential to understand the risk you may have if a sizable portion of your net worth is concentrated within your employer’s stock. Ask yourself this – if your employer were to file for bankruptcy tomorrow, would you be able to bounce back fairly quickly, or would it be financially devastating? If your answer is the latter, you carry far too much risk.
6. Keep On Investing
In the words of Andy Samberg, “Never stop, never stopping.” If you are still working and you have a positive cash flow, don’t be intimidated by the coming recession. Keep buying. Keep investing. Your future self will thank you.
Waiting until the economy is strong again may make one feel better about putting their capital at risk, but the data is pretty straightforward; deferring your investments until the storm clouds have passed is a pretty lousy strategy.
This may seem counterintuitive, but stock returns are far greater following record-high unemployment than following record-low unemployment.
So, how does the market perform after a bottom in unemployment vs. a peak in unemployment?
|Stocks Avg. Return After Unemployment Bottoms||25.3%|
|Stocks Avg. Return After Unemployment Peaks||72%|
Five years after a bottom in unemployment, the S&P 500 returns a 25.3% average return. Not bad. However, compare that to a 72% average return over the next five years after unemployment peaks.
Additionally, stocks are very quick to recover, given the slightest positive news. We saw this in March 2009 (Citigroup shows a profit) and March 2020 (Moderna vaccine high efficacy rate), and we will continue to see this behavior during future crises.
This is because the unemployment rate is a lagging indicator, whereas the stock market is a forward-looking indicator. Stocks are usually beat-up when the unemployment rate is, signaling better valuations.
7. Long-Term View
Understand that recessions are a normal part of a business cycle, and they come and go. They are not permanent, and things will undoubtedly get better.
As I stated a few weeks ago, recessions are not necessarily bad, just painful. They are indispensable and crucial for any society. Recessions are vital for any population to function normally. They force out excessive and poorly run aspects of the economy.
Think of recessions as the natural selection process of an economy. Just as natural selection favors traits and attributes within all populations of organisms, recessions favor companies and individuals that do the same while forcing out those that perform poorly.
Economic Darwinism leads to an efficient resource allocation because those firms with low profits are forced to quit while productive ones survive. Those surviving businesses offer higher value to consumers through higher quality and/or lower cost.
This reminds us that business cycles do not have to be overwhelming and highly emotional. They can instead be a normal part of life (they are), and if we are well prepared, we can profit off such volatility.