No one knows when the next financial downturn will hit, but everyone can take steps now to prepare for it.
With markets becoming more volatile this week, it’s a good time to figure out if you’re ready to weather an impending storm.
“Recession-proofing your portfolio and financial life is particularly important during a time like this, when everyone knows a recession will come eventually, but no one knows when,” said Ben VerWys, senior financial adviser at Action Point Financial in Grand Rapids, Michigan.
While the economy is still strong and unemployment is still relatively low, it’s a good opportunity to re-evaluate your goals, rebalance your portfolio and review your debt and cash levels.
Re-evaluate your goals
First, consider how many years away you are from needing to take distributions from your portfolio in retirement, said Jarodd White, financial planner with Vitalize Capital Management in Milwaukee. “The shorter your time horizon, the higher the need is to move assets from more volatile to less volatile strategies.”
Next, consider whether you’re taking on the right amount of risk.
You can stress test your current holdings in a variety of ways, but looking at how you may have fared in past downturns is a simple way to do it.
Brett N. Fry, a certified financial planner at Forteris Wealth Management in Dallas, said he shows his clients how their portfolio would have performed during past downturns, like the recession of 2008 or the bursting of the tech bubble in 2001.
“Often the investor says they could not stomach that sort of loss or volatility,” he said. “Then we know their current portfolio is too risky and they should dial back.”
Based on your financial goals, set out a plan for when you plan to withdraw your money and put it in writing.
“A withdrawal policy statement is a tool for removing the impact of emotion on your portfolio and defining exactly what you will and won’t do when a correction occurs,” said Jonathan Bird, a certified financial planner with Farnam Financial in Phoenix, Arizona.
Rebalance your portfolio
Getting ready for the next recession is different now than in the past, said VerWys. Stock market valuations are currently higher than historical norms but interest rates have also been extremely low.
“Historically, a smart move going into a recessionary period is to reduce stock risk and shore up on bonds,” he said. “Yet, this time that may not be what actually makes sense in light of low interest rates and low bond yields to investors.”
With the S&P 500 providing a 1.81% dividend yield and the 10-Year Treasury bond falling to historic lows at around 1.3%, it’s understandable why money continues to flow into stocks over the past year, said Mike Silane, managing partner at 21 West Wealth Management in Irvine, California.
But those who need to access the funds in their portfolio over the next few years should consider taking some of their gains and reinvesting them in short-term bonds, CDs or money market accounts, he said.
The decision about when to sell a stock that’s performed well is never easy.
“Selling, or not selling, is often met with regret or missed opportunity,” Silane said. But it doesn’t have to be an all or nothing decision. Consider selling one half or one third of your position. “By selling a portion of your holdings you are at least partially right no matter what happens.”
Longer-term investors — those looking at horizons of ten years or more until retirement — should not try to time the market but rather more broadly diversify their portfolio into other equity classes or styles of investing, he said.
While large cap growth stocks have been strong market drivers over the decade, investors should consider adding exposure to value stocks which have lower valuations and higher dividend yields, Silane said.
“Growth stocks tend to get hit much harder during recessions as their lofty valuations get compressed and their lower yields or no dividend yields at all, make them less attractive investments when times get tough,” he said.
Review debt and cash levels
Before a financial downturn hits, work to pay down your debt and increase your savings while you can.
“It is vital that during a recession you stay away from debt as debt magnifies losses,” said Silvia Manent, a certified financial planner at Manent Capital in Boston. “Using leverage these past ten years has been very rewarding, but it’s important to slowly scale back.”
Ensuring that you have access to cash during a downturn can also be the key to weathering the storm.
“The best thing that people can do to recession-proof themselves is to have access to cash in some type of emergency fund,” said Pamela J. Horack, a certified financial planner with Pathfinder Planning outside Charlotte, North Carolina.
During the Great Recession, mortgage holders with more cash on hand experienced lower levels of loan default, according to research from the JPMorgan Chase Institute, which showed borrower’s liquidity can be more important than borrower’s equity.
“The people hit hardest were the ones with no real savings,” Horack said. “These families had mortgage payments, credit card bills and funds in their 401(k) for retirement, but didn’t have an emergency fund they could easily access. With a job loss, they had no income, no emergency fund, and were already one month behind on bills.”