In an uncertain economy or volatile stock market, fear and recklessness are the biggest enemies of the disciplined long-term investor. The former can cause otherwise good people not only cease adding fresh savings to their complete portfolio, but in the worst cases, to sell their partial ownership in businesses (shares of stock) that will very likely be worth substantially more in ten years at depressed prices. The latter can result in more money than one can afford to lose being poured into equities because stocks are “cheap” so the lure of leverage in the form of margin debt becomes too powerful to overcome. The great tragedy in cases such as this is that the investor might ultimately be proven correct, but lacks the net worth to survive a margin call, getting wiped out in the process as he watches others get rich off his ideas.
This article was put together to help small investors reduce their risk during economic recessions; because each individual is obviously different, you need to consult with a knowledgeable and respected financial advisor or accountant to help you come up with a strategy for your individual circumstances. Otherwise, you know the drill: Go grab a cup of gourmet coffee, print out a copy of this resource, curl up in a chair, and get started on turning your personal balance sheet into a bastion of financial strength for your family, enabling you to sleep well at night. If you are looking for specific investment questions to consider during a recession, read Managing Your Portfolio During a Recession for more great ideas.
1. Build and maintain your liquidity at nearly all costs
I want you to think about the following statement. People don’t go bankrupt because of the total debt they owe; they go bankrupt because they miss payments and the financial institutions then foreclose on or take other measures against them. In the past, we’ve covered the topic in several articles including A Lesson from September 11th - The Importance of Liquidity and Liquid Assets and Why Building Equity at the Expense of Liquidity Can Lead to Bankruptcy.
What does this mean? In simple terms, having a comfortable cash cushion is very much like the safety net under the trapeze artists at the circus. If something were to go wrong, such as you or your spouse losing a job, business turning down, or your company reducing work hours for staff, you’d be able to draw upon those funds to keep the electricity and water working, gasoline in the cars, and food in the kids’ lunch boxes. It doesn’t mean the experience will be stress-free, but it could help ease those difficult times until you get back on your feet.
It is absolutely vital that emergency funds be kept entirely in historically safe, liquid areas such as savings and checking accounts at well-capitalized, FDIC-insured banks, United States Treasury bills, money market funds, or if you are the extremely paranoid type, stacks of dollar bills parked in a safe deposit box. Do not comingle your emergency fund with your regular bank or brokerage accounts because it will be too tempting to spend or invest the money! The reason is simple enough: The purpose of this money is not to grow. It is not to make you rich. It is meant to be spent only if and when you are unable to pay your bills through other means. It is the last resort fund.
2. Maintain sufficient health, life, disability, and other insurance
During hard times, it can be tempting to cut expenses in areas that don’t seem important. For many people, this includes insurance coverage. In many, many cases this is a horrible mistake that can lead to total financial destruction. Imagine, for insurance, if you were to get rid of your health insurance with the intention of picking it up later when times were better. What if you or your spouse had a heart attack or were diagnosed with cancer? What if your children developed a rare infection? Life events such as these rarely provide warning and believing that you have the God-like power to predict them could cost you your house, cars, and retirement. Don’t be stupid.
Unless you are independently wealthy with piles of stocks, bonds, mutual funds, businesses, real estate, et cetera, your most valuable asset is probably your ability to work. That’s the reason disability insurance is vital for most American families. Depending upon the coverage chosen, a good policy can send you a paycheck if you are unable to support yourself.
3. Cut Unnecessary Expenses – And Pay Off Credit Cards!
Even if you don’t feel any financial pressure, if you believe there is a reasonable chance you might be hit by a recession, start cutting unnecessary expenses, using the excess cash to start the process of de-leveraging your balance sheet if possible upon the advice of a qualified financial expert familiar with your situation. This will lower your fixed payments each month, making your emergency fund go further than it otherwise would have. Start with the obvious stuff – the $4 cups of cappuccino, the magazines at the newsstand, fast food, etc.
If you have credit card debt, pay it off immediately! Not only can you not afford the sky-high interest rates that you are likely being charged by your bank or financial institution, if things get really, really bad, you might just need that backup source of liquidity your credit lines afford you. If you are already maxed out, they won’t be there, making the problem worse.
On that same note, if you have margin balances at your brokerage firm for any of your investment accounts, seriously consider paying them off as soon as possible. When the economy gets rough, undisciplined investors are often forced to sell their holdings, temporarily depressing prices for those who were fortunate and wealthy enough to hang on to their shares of stock. This means that if you have a margin balance, it’s possible for your account equity to fall below the maintenance requirement set by your financial institution or, in some cases, the Federal Reserve. If that were to happen, you’d need to come up with money that very instant to avoid having them sell off your assets at already-depressed prices, compounding your fiscal pain.
