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How to prepare for a recession

How to prepare for a recession (and so avoid becoming an itinerant bandit like Mad Max, pictured)

The vote to Brexit has sent the UK into a state of upheaval. At times it’s felt like a mashup of The Thick of It meets Big Brother.

Indeed if we are living in a computer simulation – as Tesla’s Elon Musk recently reminded us is probably the case – then ours seems to be scripted by Monty Python. A sort of Sim and Insensibility virtual reality game for political masochists.

We thrashed it out in the comments, and rarely was much twain met.

Enough!

The question now is what should you do as a financially-engaged citizen to best navigate whatever comes next?

Winter is coming. Probably.

Some think the UK will see no consequences from the decision to Brexit.

But most agree the uncertainty alone will cause at least a short-term dip.

Personally, I think it’s a good time to batten down the hatches:

  • Bank of England governor Mark Carney says the risks he foresaw are crystalising.
  • The pound touched a 35-year low as global capital has bailed.
  • Shares in UK focused companies such as UK banks and housebuilders are down 20% or more.
  • Retail footfall fell 11% year-over-year after the vote.1
  • The GfK consumer confidence index has seen its sharpest drop for more than 20 years.
  • Online job adverts halved in the week following the result.
  • Property funds have locked-in nervous retail investors.
  • Two-thirds of Institute of Directors members polled say the Leave win will hurt their businesses.

I don’t say a recession is a certainty. Nobody can.

However on balance I think some sort of slowdown is very likely – if only a technical recession2 – and has possibly already begun.

Here’s one forecast (from KPMG) on the potential impact of Brexit:

Brexit-short-term-recession

Source: KPMG (May 2016)

All the ingredients are there for a potential recession, but will KPMG’s tea leaf reading prove 100% correct? Very unlikely. Comprehensive forecasts are never entirely right (and usually somewhat wrong).

But it looks like a fair stab at predicting the near-future, and in-line with most informed takes I’ve read.

At the least: The range of potential outcomes has increased, and greater uncertainty means greater risk.

Things may well turn out for the best. But when the potential downsides have magnified, then I believe it’s only logical to get more defensive with your personal finances, and perhaps with your investments, until we have a clearer sense of what’s going on.

And hey – if everything turns out rosy then at worst you’ve saved more money!

How to prepare for a recession

Most of us have lived through one or more recessions. How they affect you really depends on the severity of the recession, and your circumstances at the time.

  • Someone who keeps their job, enjoys seeing their mortgage costs fall, and watches their investments rise with a weak pound might not even notice.
  • Somebody who has overstretched themselves financially, can’t find work, and has nothing to fall back on could be scarred for life.

We have a safety net in the UK. Our taxes fund a decent welfare system and a free-to-use health service, so we see fewer of those middle-class to middle-of-the-highway stories you read about in the US.

But there are less dramatic ways to suffer from a recession – especially if you’ve got dependents – and they’re all best avoided.

How? Act early, reduce risk, shore up your position, and revisit every expense.

Act early

Get started with this before a recession is obviously upon us.

Some will say this is scaremongering, or that if everyone acts this way then we’ll talk ourselves into a recession.

I say: Not my problem!

Just as I thought the bank runs of 2008 were perfectly rational, I’m not interested in whistling past a potential graveyard in order to take one for the team.

Besides, my website statistics tells me only a tiny minority of the UK population reads Monevator.

Inexplicable, but we’re unlikely to trigger financial Armageddon on our own.

Reduce risk

It’s not the pension portfolio that you don’t need to touch for 30 years that kills you in a recession.

It’s your family’s pricey second car, or your financially shaky buy-to-let, or the dubious business venture that goes wrong, or the personal loan you never paid off.

“It’s only when the tide goes out that you learn who has been swimming naked,” says Warren Buffett, gazillionaire.

Make sure you’re covered.

Shore up your position

What do you take for granted now that could look precarious a year into a deep recession?

Your job? Those tenants who are always two weeks late with the rent? Your depleted emergency fund?

Think doubly hard if you’re a small business owner or contractor.

To mix my metaphors – show some love to your golden goose, and throw out any rotten apples.

Revisit every expense

Zero-based budgeting is all the rage in racier boardrooms. It entails going through every expense a company has at the start of each period, and justifying or rejecting its continued existence.

Just like companies acquire bloated payrolls or costly perks in the good times, so our own household finances might be carrying a lot hangers-on – from rarely-used gym membership to that £100 a month you’ve been subbing to your eldest son for beer money at Uni without telling your partner.

Purge! Purge it all!

Some ideas to get you started

This kind of household right-sizing is obviously down to you as an individual. You know how much you earn, what you’ve got invested, where you’re wasting money, and what you can’t do without.

You need to work out what matters most to you.

Here’s some ideas to get you thinking.

Act early

  • Take responsibility.
  • Set aside a weekend to do a statement of affairs. Are you solvent?
  • Many people find creating a budget is helpful to learn where their money is really going.
  • Begin a conversation with your partner. You don’t want to shock them in six months when that cottage in Devon is, um, sold.
  • If you have a financial advisor you trust, now might be a good time to visit them.
  • Back up your earnings. Consider looking for additional work, ideally separate to your main employer. Even just a couple of evenings a week. If you’re made of fancier stuff, could you add some consultancy or similar to your roster?
  • If your employer says they may need to let people go if things don’t get better, quietly consider yourself fired TODAY and go into survival mode with respect to budgeting and saving. Better sooner than later. (Perhaps look for a new job, depending on your circumstances. But certainly save all you can).
  • Be prepared. Will you be offered a redundancy package? What happened at your company in the last recession? What are your rights?
  • Read your contract.
  • Run your own business? You’ve got to balance taking evasive action now (and doing the sort of things I’m discussing here on steroids) with potentially missing out if things turn out alright yet you’ve reduced your capacity too severely. Still, the first cut is often the cheapest.

Reduce risk

  • Get out of debt.
  • Seriously – if you’ve got anything but mortgage debt, then start figuring a way to pay it off as your top priority. Work evenings. Sell furniture. Eat healthy and ultra-cheap.
  • Repair or enhance your emergency fund.
  • Reevaluate your racier investments. Thinking of getting into buy-to-let? Perhaps give it six months. Own five flats already? Maybe sell the weakest one. Can you really risk owning that quarter-paid-for holiday home? (Perhaps – as I say this isn’t one-size fits all. My point is you should look objectively at your situation).
  • If you’re a passive investor, make sure your asset allocation is good for all-weathers. Don’t be reactive, but if you were cutting corners with diversification in the first place for no good reason, it’s time to get sensible.
  • If you’re an active investor, make sure you’re not invested in crazy blue sky story stocks at the expense of sensible investing. Now might not be the best time for ‘fun punts’.
  • Either way, are you over-invested in equities? Shares are jolly when the market is going up. Not so much if they halve. If you’re on track to hit your number at a lower level of risk, why are you taking on more?
  • Make sure any essential insurance – vehicle, home insurance, life insurance if you have dependents – is in place.
  • Consider additional insurance if you’re very concerned, but do your research and get advice if required. (Insurance to cover vital payments or potential redundancy sounds great, but not if it costs you a fortune, impoverishes you, and doesn’t pay out when you need it. I’m no expert on this, but the advice is out there).
  • Peer-to-peer lending could be tested in a downturn, especially the more exotic offerings offering 10%+. Don’t be greedy.
  • Favour liquidity. Remember cash is king in bad times, and triply so if you lose your job.
  • Personally I’d consider holding on to cash rather than making over-payments on a mortgage at today’s low rates if you’re short of non-property assets. Again, cash is king – provided you can trust yourself not to spend it. Ideally you’d do this with an offset mortgage, but even keeping an extra £5,000 to £20,000 in something like Santander’s 1-2-3 account rather than overpaying your mortgage – and hence locking up your money – will give you more flexibility.

Shore up your position

  • If you’re like most people, your salary is your most precious income stream. Look after it!
  • Try to be a profit center, not a cost to carry.
  • Use the same techniques you’d apply to getting a raise to make yourself less dispensable in a downturn.
  • Do all this before anyone else is thinking about it.
  • If you’re a freelance or a contractor, you could be culled first. At least be likeable, dependable, and add value.
  • Get more clients.
  • Get new clients.
  • Try to make sure all clients are good to pay. Chase late payers!
  • Consider getting an extra job, or some other way to earn extra money.
  • Better yet, send a sit-at-home partner off to work too for a bit every week. Even £50-200 a week can be very helpful if things get tough, depending on your household’s burn rate.
  • Can you increase your monthly contributions into your emergency fund?
  • Can you build a bigger cash buffer some other way? (Sell something!)
  • If you’ve got a lot of cash saved beyond your emergency fund that you don’t need to access, it might pay to lock it up for a year or two before the best fixed rate savings offers are withdrawn. (Ideally choose one with some sort of emergency early access).
  • Consider remortgaging your home to secure a longer-term low-cost fixed rate. It may work out more expensive, but it could be worth it for the security. Decide what matters most to you.
  • I’d try to keep investing for the long-term, even a small token amount each month. (If you have found this website and you’ve read this far then there’s almost certainly one more thing you can cut to maintain the investing habit.)

Revisit every expense

  • Stop smoking.
  • Do you really need gym membership? Use the stairs and do press-ups.
  • Do you really need Netflix as well as Sky and Amazon Prime?
  • Do you really need Sky and Amazon Prime as well as Netflix?
  • Etc.
  • Look at all your household bills. Switch suppliers to save £25 off gas, £15 off electricity and £5 off water a month and you’re banking an extra £500 a year.
  • Can you reduce bills further by paying by direct debit and so qualifying for a discount?
  • If you pay taxes on dividends or interest and you’ve got an unused ISA allowance, you’re an idiot. Taxes eat your wealth.
  • Sell your expensive car or get out of your lease contract, and get something cheaper. Maybe a bike or in London an Oystercard.
  • Could your family take a holiday closer to home so you can sock away an extra wodge for a rainy day? (Mauritius can wait for the next boom…)
  • Choose to rent somewhere a bit cheaper if you’re currently looking. If we do enter a recession then haggle even harder to reduce your monthly rent.
  • Own your own home? Is your house a 90%-mortgage backed indulgence that you can only really afford if both of you keep your jobs and all your bonuses come in on-target, just like in the good times? Really? Might want to rethink that.
  • Watch out for frivolity-creep like daily lattes or e-books you never read or the occasional takeaway blowout that’s become a Friday night staple.
  • Have you been supporting family members, or direct debiting into a niece’s Junior ISA? Good for you, but if your numbers are looking tight you may need to stop it. You have to look after your own first. Try to make it up later.
  • Sell your super-yacht if you’re rich. Skim through these 101 money saving tips if you’re not.

Also see my co-blogger’s excellent article on saving tips for a more motivational pep-talk. He went from a big spender to a master saver through the judicious use of a budget.

More ideas? Please add them in the comments below.

Stay alert for surprises

Because so much is now potentially in flux, it could pay to be even more engaged with your finances than usual.

I’m not talking about swapping passive investing for twitchy day-trading.

If you’re a passive investor with a proper asset allocation, leave it be. (You’ll probably do better for it).

However with your personal finances – or any active investing you engage in when The Accumulator isn’t looking – this is not the time for complacency.

Surprises could be positive or negative. Political risk is elevated (though Theresa May becoming Prime Minister will definitely sooth some nerves). Future policy responses might soften or delay the blow – at least for a while.

The Bank of England will almost certainly cut interest rates to 0% in the days and weeks ahead, for instance. The relative futility of that gesture means it’s also highly likely to restart QE.

That would be bad for savers who leave their cash languishing in terrible savings accounts. But it could be good for other kinds of investments.

I also expect various government actions to try to puff up animal spirits – or even just to inject cash into the economy.

Besides approving new airport runways or similar, this could involve things like cutting corporation or capital gains tax, further changes to stamp duty, and perhaps panicky measures like the financial crisis’ temporary cut in VAT.

The State’s strained finances will be weakened by any recession, however, so ministers might decide to try to make up the difference with tax raids, such as re-freezing the higher rate income tax threshold. (Could you re-budget to save more into your SIPP if they do?)

Even if you’re confident you’ll retain your earnings power in a recession, being nimble might help you grow your wealth.

Hope for the best, but prepare for the worst

The lower pound should prove stimulative, eventually, should it persist for more than a few months.

If you’ve got a globally diversified portfolio then it should have already cushioned some of the existential pain at home by boosting the value of foreign assets – as well as the share prices of companies that earn most of their money overseas, like the bulk of the FTSE 100.

And with luck this will be just a UK recession. If it sparks off something serious in Europe or wider still, then any pain will cut deeper.

On a national level the weaker currency will probably initially be negative due to it pushing up import costs, but over time improved competitiveness should boost overseas sales.

Conceivably your job might even be more secure now if your customers are in the US or China rather than in a housing estate down the road or, perhaps, France.

So stay alert to your own situation.

In the long-term, I’m not at all optimistic that Brexit will lead to a stronger economy than if we’d stayed in the EU.

But equally I don’t think the world is ending.

While we wait to find out, let’s be careful out there.

Please note: Suggestions as to how other readers might take action ahead of a potential recession are very welcome, but no political debates today please. If you think there’s not going to be a recession, good for you. Maybe there won’t be. This isn’t the post for discussing why. To keep things on track for the majority, I will be deleting off-topic commentary. Thanks! 🙂

  1. Careful with this though, the weather has been diabolical this summer. []
  2. A technical recession is two quarters of negative growth. Like British summers they don’t amount to much and can be easily missed. []

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{ 70 comments… add one }
  • 51 Miles July 14, 2016, 11:55 am

    Another really useful post, thank you.

    My passive portfolio – which owes much to Monevator for its construction thank you – has fared well since Brexit. However having set up the allocation in line with risk v return targets, I did not – at the start – have a planned timescale for if, when and how, to reduce equities exposure in the run up to drawdown.

    My allocation is 70% equities (15% is exposed to UK equities), 20% bonds, 10% cash including P2P. I can take more risk than some because I also have a mortgage free BTL.

    But this latest post makes me wonder whether now is the time to reassess my asset allocation in the run up to drawdown. My investment horizon is about 5 years, which is probably the time during which any impact of Brexit will be most dramatic. On the other hand, unless the EU project falls apart as a result, the fortunes of the UK is unlikely to have any major impact on the global economic outlook. So any comments or suggestions about my asset allocation would be very welcome.

  • 52 Rob July 14, 2016, 12:33 pm

    Hi @Fireplanter – I don’t think you’re likely to be missing out out on anything, except perhaps the apostrophes – cash and UK gov’t bonds 😉

  • 53 gadgetmind July 14, 2016, 12:43 pm

    @magneto – I expect inflation of nursing home fees will be a major problem! And unless sterling somehow recovers, that inflation forecast seems about right to me. Take a look at the prices of inflation linked gilts (such as the INXG ETF) to see what markets expect.

    Of course, they could be wrong, but even so …

  • 54 Rob July 14, 2016, 12:48 pm

    @The Rhino – Haha, yes, does seem a bit like that. But really only by 10% or so if all your expenses are in dollars and/or other foreign currencies.

  • 55 The Rhino July 14, 2016, 1:07 pm

    @Rob – absolutely, I noticed that cool bike I like the look of is still the same price in £ as it was a month ago, yet my portfolio is up ~10% in £ so all good for the moment..

  • 56 The Investor July 14, 2016, 1:09 pm
  • 57 Rob July 14, 2016, 1:26 pm

    Sounds like a free bike to me…

  • 58 Fireplanter July 14, 2016, 3:28 pm

    I don’t believe in freebies. There’s the opportunity cost……..

  • 59 The Rhino July 14, 2016, 4:43 pm

    Another creative accounting technique I use is to offset any bike cost against the money saved by commuting on bike rather than car/train – so all my bikes are free anyway regardless of brexit.

    I earn £3.40 per hour that way. Its a bloody hard way to earn a living. I haven’t been paid that little since I was a kid. But it adds up – since the 1st time I rode in to work (18/06/2013) I’ve saved £1324.90 and covered 10,339km. I think the value prob isn’t in the £s but in the legs and lungs.. I have been run over 3 times though as well in that period so its cons as well as pros..

  • 60 gadgetmind July 14, 2016, 6:44 pm

    I love cycle commuting. My employer pays me a travel allowance, and a car allowance for not having a company car, and does a Cycle To Work scheme every year. On top of that, I’ve also had a total of £5k+ from insurance companies after dozy drivers have driven into me, so yes, cons!

    Top tip: Get a video camera and use it on every trip.

  • 61 John B July 14, 2016, 11:37 pm

    That’s one way to supplement your income in a recession, become a Slipping Jimmy!

  • 62 The Rhino July 15, 2016, 10:17 am

    @JB haha – never heard that phrase before – had to look it up. I’m no slipping jimmy like GM, the Rhino is a too hardy a beast for that sort of game.

  • 63 Planting Acorns July 15, 2016, 4:05 pm

    Funnily enough I just renewed my Vodafone sim only contract…4gb data, 1000 minutes, unltd texts and 500gb EU data for £10.80 a month…with two months free !

    I’ll buy a new wileyfox swift when this one gives up the ghost.

    That said… I’m itching to borrow to invest…I spoke with my bank who would extend my mortgage by another 1 times salary and fix it at five years for 2.39pc… if HSBC is right and inflation does rise I’ll be able to inflate my debts away with a whole load of assets to show for it…

    Ah, they don’t say patience is a virtue for a laugh…

  • 64 Alice Holt July 15, 2016, 9:28 pm

    Be aware that the benefits safety net is rather threadbare.

    For instance, Job Seekers Allowance (JSa) is £73.10 per week. For those receiving contribution-based JSa, payments stop after 26 weeks.
    If you have a capital over £16k, or a partner working 24hrs or more pw then that £1,900 (less your job-seeking expenses) is the sum total of help you will get with living expenses.

    If you are unfortunate and fall ill / experience disability, with much reduced chances of finding work, then the situation is truly bleak.
    The benefit for those judged not fit for work (ESa) and placed in the Work Related Group is £102 pw (falling to £73 pw next year). Even with Housing Benefit (help for those renting their home), and a discount on Council Tax, long-term financial survival is a very difficult.
    The stress of this, together with coping with an illness, and the frequent flawed DWP work capability tests, often result in people with physical difficulties developing depression and other mental health problems.

    Working as I do at an advice charity, I can only re-inforce the importance of having an adequate emergency fund.

  • 65 gadgetmind July 16, 2016, 8:32 am

    @JB – We’ve never struggled to find worthy things to spend the money on, but let’s just say that I invest a lot of energy and attention towards not getting broken bones. However, some car drivers seem more intent on “CUL8R LOL” than looking out fir cyclists! Most of that money was for a fine collection of broken ribs, which hurt like hell and are best avoided.

  • 66 Mroptimistic July 16, 2016, 9:28 am

    The big risk to my financial future is inflation once I am locked into a fixed income stream with limited protection (rises capped at 5%). This is causing me to explore transferring a DB pension into a SIPP. This brings the issue of what to invest in if I do this. I like the idea of the Vanguard lifestrategy funds as a core but I am no longer persuaded by the equity/ bond asset allocation arguments. These are not normal times and the bond market is now vulnerable. Bonds are not safe over a 10 year timeframe. In my view now, it comes down to linkers as the best of a bad job, equities and cash. Instead of a 50% bond allocation I think 25% IL and 25% cash is much better. Of course when inflation moves the cash has to be invested but at that time the bond markets will already have cooled. With current low inflation and low bond yields cash is a valuable asset!

  • 67 magneto July 16, 2016, 5:10 pm

    @ MrOptimistic
    Some queries :-.

    Rises capped at 5%. Is that bad?

    Can a proportion of DB pension be transfered to SIPP?
    Some of each (DB + SIPP)?
    I.E. Diversification of Risk?

    Has the generally long duration risk of IL Gilt Funds been factored in, or are individual IL Gilts being contemplated?

    How poor is the yield on capital in the DB Pension?
    A key question!
    Might not DB Pension be the least worst and perhaps even the safest option?

    In your shoes would take some time on this very important issue!
    Would also seek independent advice!

    All Best

  • 68 Mroptimistic July 17, 2016, 6:33 am

    Yes, given the pension prospects for the younger generation have to be careful not to moan! Another objective I shall fail with. Have to get independent advice by law if more than £30k at stake. Not an easy decision. However owing to a job change I have two DB pensions so the idea was maybe switch one. It’s an all or nothing thing, can’t do it by proportion although as a fall back you can take the 25% tax free bit out.

    Thing is, being of an age which has seen some periods of high inflation, a burst of inflation significantly above 5% would be harmful and once out of work there is no question of increased pay eventually compensating for it.

    The DB doesn’t have a meaningful yield on capital, however the transfer value may be something like 25:1. So a £5k pension becomes £125. Then you subtract the advisors fee and start paying SIPP charges, say 1% PA.

    Yeah the duration of IL funds is hard to dig out. Think it’s 24 y?ears for the L&G tracker, much too long. Better to hold directly. Bond funds are not the same as holding the bonds: can’t just sit and wait for redemption at maturity.

  • 69 Comet July 18, 2016, 2:25 pm

    So cash is king, but QE will hurt cash savings.

    I’m roughly 50:50 equity/cash. Not sure if I should change this. I think I may have to bite the bullet and see an IFA.

  • 70 Mroptimistic July 18, 2016, 8:01 pm

    No one knows, these are uncharted waters. In terms of my emotional asset allocation, given I am past 60 and staring retirement in the face, I reckon 60% capital protection, 30% income and 10% growth.

    The magnificently open and clear minded articles on this site are the equal of any half parsed IFA. No point going to an IFA if the real issue is lack of certainty over your objectives. Age is a big factor. If you have time, but you are reasonably sure you will not have sufficient in x decades, then why cash or bonds?

    If you haven’t time then irrespective of any other wish, income, growth etc, capital preservation comes first as without this you get nothing!

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