The recent changes in the economy and the threat of recession can leave you concerned about protecting your finances. Here are 5 tips on how to help protect your wealth during a recession.
1. Keep adequate cash reserves on hand
Recessions typically mean higher interest rates, challenges for the earnings of companies that result in dropping stock prices, and ultimately job losses as companies are forced to lay off part of their workforce to shrink their costs. It’s prudent to always keep 12-18 months of living expenses in cash as reserve in case of a loss of income or stock market losses. By having cash set aside to cover a year or more’s worth of spending, you can maintain your lifestyle, even if you needed to look for another job or ride out the stock market downturn. Cash allows you to keep spending, without having to sell assets from your portfolio while their values are down.
2. Look for opportunities to earn more income due to higher interest rates
Higher interest rates can present challenges as the costs of goods, services and debt rise. This creates higher expenses for most everyone. But higher interest rates also mean that many people can increase how much income they make from their investments.
Fixed income investments, such as Treasury bills, bonds and CDs are paying much higher interest rates than they were a year ago. A savvy investor can look for opportunities to buy bonds or CD’s paying over 4% in interest in today's market. Online savings and money market accounts are paying around 3% as of the writing of this article. Investors and savers can consider exploring these new opportunities as a way to increase the interest income they receive from their savings. Many people are still holding cash in their normal savings accounts, so considering other options can help one earn more on their savings. The more one earns on their money, the better they can be positioned for dealing with rising costs.
3. Consider adding dividend stocks to your portfolio
High quality dividend stocks with solid cash flows have also lost some value in the market downturn, which means an investor can pick up strong dividend income for a lower price. Companies with strong balance sheets, favorable free cash flow and a solid position in their market have historically been able to maintain their dividends, even in challenging market conditions. And dividend paying companies, especially those that continue to grow their dividends, have historically held up better than other companies during a recession. Dividend payments are a positive source of return and cash flow, even if the price of the stock is flat or declining. Dividends can either be taken as cash, to support income when higher prices or reductions in work income; or they can be reinvested, potentially at lower prices during a stock market decline.
Keep in mind that all stocks, dividend paying or not, present the potential risk of losing significant value. They are not appropriate for all investors. Investors should consider their tolerance for risk, their overall financial goals and means, and consult with a financial advisor before making any investment decisions.
4. Avoid taking on new debt
With interest rates climbing, the overall cost of borrowing can become a burden to maintaining one’s lifestyle. 30-year mortgage rates, as an example, have recently climbed to above 7%. As rates on loans for houses, cars, recreational vehicles, and boats have climbed, the overall cost to finance a purchase has risen significantly.
If one can avoid taking on new debt, they can avoid the increased interest costs. It may make sense to maintain a mortgage that was locked in under 3% a few years ago, rather than paying it off. It might also be worth considering sticking with your current home or vehicle for a few years, rather than upgrading while costs are high. Higher borrowing costs often lead to the prices of the item to be purchased to come down over time. Delaying a new purchase could potentially protect you from higher interest expenses and help you get the item at a lower price in the future.
5. Maintain your long-term strategy
While recession can cause financial challenges, even significant ones, it’s important not to abandon your long -term plans due to current conditions. History has shown that recessions tend to be shorter than growth periods, and some of the most significant gains in the stock market come shortly after a recession ends.
Since no one can predict the exact timing of a recession or recovery, it’s important to maintain an allocation to growth assets, within the parameters of your overall risk tolerance and time frame for using your portfolio. If one has adequate cash reserves and short-term income investments that can be draw on throughout a recession; they can keep the remainder of their portfolio allocated to risk assets, like stocks, that are likely to recover when the economic pressures of the recession are over.
Money is lost permanently when one sells their stocks while the prices are down in a recession or bear market. But maintaining other reserves to use if needed and sticking with your growth assets through the tough times, can help you remain invested until the temporary losses are recovered.
Consider these 5 tips to help you protect your wealth during a recession. If you need additional help with your financial situation, schedule a call with us for a free assessment.
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About the Author:
David Edmisten, CFP®, is the Founder of Next Phase Financial Planning, LLC, a financial advisor in Prescott, AZ. Next Phase Financial Planning provides retirement, investment and tax planning that helps corporate employees retire with both financial and lifestyle security.