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How to prepare for a recession

Posted By The Investor On In Updated,Monevation,Commentary | Comments Disabled

Note: This article on recession preparation has been updated in light of the COVID-19 virus pandemic.

The coronavirus is upon the West. Stock markets are in free-fall [1].

Almost all measures that can slow the virus down and save lives will hit economic activity.

This challenge could persist until we see a vaccine or until as a species we develop some resistance to the virus.

I don’t say a recession is a certainty. Nobody can. Central banks are taking extraordinary measures, and politicians are belatedly following. Perhaps – cross everything – the virus threat will abate as the weather warms up in Europe.

But it seems beyond doubt that the hospitality sector – pubs, restaurants, event companies, hotels, and many more – are going to be hit for six by any lockdown.

And this will have knock-on consequences throughout the economy.

Winter is coming

Unfortunately, things could get a loss worse.

The latest figures [2] from China show how its measures crushed economic growth.

China’s disruption happened at a time when the rest of the world was pretty much untouched by the virus. Major economies like the US, Germany, and Japan were bouncing back from the US-China trade war. Britain had its Brexit folly, but that had already slowed us and negotiations seemed likely to drag on indefinitely so it wasn’t an immediate threat.

Today things are very different. Workers in countries everywhere are downing tools and staying indoors. Videoconferencing suppliers may be booming – Netflix shares rallied in the early weeks of the crash as a stay-at-home trade – but airlines and cruise operators will probably go under without state bailouts.

On balance I think some sort of sharp slowdown is very likely. At the least a technical recession seems probable1 [3]. But we can’t rule out something much worse.

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

Things may well turn out to be less bleak than feared – especially as there’s enough fear around at the moment to push even the sunniest disposition towards catastrophic thinking. Maybe the market is overreacting.

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 – there’s very rarely a personal disadvantage to saving 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.

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 [4] 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 only a tiny minority of the UK population reads Monevator.

Inexplicable I know, but our readers are unlikely to trigger financial Armageddon on their 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 that you stretched to borrow for a second car, or a financially shaky buy-to-let, or a dubious business venture that goes wrong. It’s 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 geese, and throw out any rotten apples.

Revisit every expense

Zero-based budgeting is all the rage in boardrooms. It entails going through every expense a company has at the start of each period, and justifying 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 a rarely-used gym membership to £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 [5].

Here’s some ideas to get you thinking.

Act early

Reduce risk

Shore up your position

Revisit every expense

Also see my co-blogger’s excellent article on saving tips [31] 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 [32] for twitchy day-trading.

If you’re a passive investor with a proper asset allocation [33], 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. Future policy responses might soften or delay the blow – at least for a while.

We’ve already seen the Bank of England cut Bank Rate to 0.25% and introduce a range of other emergency measures [34]. It could well cut rates to zero.

It’s all bad news for savers with cash languishing in terrible savings accounts (and for banks for that matter). But it could be positive for some other kinds of investments, especially government bonds [35].

I also expect various government actions to do more to try to revive animal spirits – or even just to directly inject cash into the economy.

Besides approving infrastructure projects or similar, this could involve things like cutting corporation or capital gains tax, a stamp duty holiday, and perhaps even dramatic measures like the financial crisis’ temporary cut in VAT.

A pandemic is an unusual sort of economic meteor, however. Cutting rates and taxes to encourage us to go out and spend more conflicts with medical guidance to stay indoors. Perhaps more direct support to stop previously viable businesses going bankrupt before better times return will need to be considered.

The State’s strained finances will certainly be weakened by any recession, so we can expect tax rises down the line.

Hope for the best, but prepare for the worst

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

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 in sterling terms – as well as the share prices of companies that earn most of their money overseas, like the bulk of the FTSE 100.

However at the time of writing this looks like being a global retrenchment. We’re all in it together – and that includes our stock markets – so unlike the Brexit hit in 2016, foreign markets are not going to offset the pain. Owning top-quality bonds [36] and having a chunky cash allocation has been the only real safety cushion to-date.

In the medium-term, the virus should pass. I don’t think the world is ending.

However there’s a danger we get into a self-reinforcing downward spiral – or that civil unrest or other kinds of unforeseen disruption such as a credit crisis make matters worse.

Let’s be careful out there.

Please note: Earlier comments on this article may refer to previous recession scares – I’ve left them in for historical interest. Other suggestions as to how readers can take personal finance related action ahead of any recession are welcome.

  1. A technical recession is two quarters of negative growth. Like British summers they don’t amount to much and can be easily missed. [↩ [41]]