COVID-19 has increased the possibility of a global recession by wreaking havoc on global supply chains, global demand on retail, hospitality and travel and not to mention the lives of 3,800 people worldwide.
A recession is a period of economic decline. During a recession, unemployment will rise, manufacturing and retail sales will decline and the economy will produce less goods and services overall.
Recessions are part of the business cycle and they are normal. They will happen – it is not a question of ‘if’ but ‘when’.
It is therefore important to have a plan to better prepare oneself for recession because it can have negative financial consequences.
This plan will have two main parts:
- Preparation before recession
- Plan of action during recession
Preparation Before Recession
When we enter a recession, the worst thing that could happen is the lost of our regular source of income. If we also happen to have liabilities, the lost of income might affect our ability to repay our debts which have further negative consequences.
Therefore, in order to survive this period, we must prepare for alternate sources of income and reduce as much liabilities as possible.
#1 Safety Nets – Emergency Fund and Insurance
During a recession, the only reliable source of liquidity is the cash we have on hand and in our savings.
An emergency fund will act as an emergency source of income should we lose our income during the recession. This extra amount of savings will help cover our expenses without having to liquidate our investments.
A typical emergency fund could be 6 months of your monthly income. Or it could be 6 months of your monthly expenses. But do note that the latter option will be lesser and thus provide less buffer.
Personally, I would save at least 6 months of my gross income because I am more conservative and having a larger amount makes me feel more secure.
Unexpected healthcare or emergency costs during the recession could be quite costly as well. So it will be a good time to review your insurance coverage.
This is especially for health insurance because we are still in the midst of an infectious virus outbreak and we have increased chances of falling ill.
It is a good time now to look at your life insurance coverage especially if you are the breadwinner of the family.
A quick rule of thumb is that the amount insured should be 10 or 15 times your annual income to sustain your family expenses for the next 10-15 years.
#2 Reduce Debt
This is another obvious step, having a huge unsecured debt or high interest payments would mean less money available for your living expenses.
Also, debt not only takes a toll on your finances, it also causes you unnecessary stress and worry. You will have enough other problems to worry about during a recession. Do not add debt on top of them.
There is also a risk of defaulting on your debts. Going through bankruptcy proceedings or debt restructuring has negative effect on your credit scores and might affect your future ability to secure a loan.
There are two strategies to eliminate debt.
Once you have made all minimum payments on all debts and you can put all the extra money leftover to pay off the highest interest debt first. Once that is fully paid off, you can move on to the second highest interest and pay off the next debt until you eliminated all debts. This is the debt avalanche method.
Another method of eliminating debt is by paying off the smallest debt first. Proceed to make minimum payments on all your debt and use the rest to pay off the smallest debt first. Once the smallest debt is paid off, you move on to the second smallest debt and pay if off. This is the debt snowball method.
Read also: debt avalanche vs debt snowball on investopedia.
#3 Upskill – Diversification of Skillsets
Upskill means learning additional skillsets that will expand your capabilities in your job or in life.
When economic activity slows down, companies may have to undertake cost cutting measures. Usually, the least efficient employees may be the first to be laid off.
So by being good at your job or being able to perform multiple tasks, you will be perceived as more valuable than your colleagues and will more likely to be kept.
However, sometimes bad luck or bad timing might cause you to lose your job even though you might be performing great – like the shutting down of an entire department or the entire company closing down.
Hence, you could also build your side hustle and develop other skillsets which may not necessarily be relevant to your work.
Should your job be affected or if you are forced to take unpaid time off, you could continue to have other means of income.
Of course, it is also important to have a well diversified investment portfolio as well.
Plan of Action During Recession
Having a general plan of action during recession is beneficial. It will be your guide to navigate through the treacherous periods of recession.
Remember that recessions are temporary and we should always stay focused on your long term goals.
#1 Budget Tightening
During periods of recession, the monthly budget becomes even more important when your income falls and every penny saved becomes much needed.
It is good to look at your overall budget and analyze where you could trim off some unnecessary expenses.
Reducing your debt is an important step to help reduce your monthly fixed expenses because interest payments can be quite costly. This should have been done at all times not just during recession.
The next areas to reduce are discretionary expenses. In other words, cutting down spending on the ‘wants’ in your budget.
Examples of expenses you could reduce:
- eating out
- traveling (COVID definitely helps with reducing travel)
- luxury items, branded clothing, cars
- online subscriptions
Another way of reducing expenses is by finding cheaper alternatives.
- Buying second hand items
- Finding inexpensive sources of entertainment: cycling in the park, visiting museums with your family
- Bulk grocery shopping
- Use public transportation, bike to work
Cutting down expenses means you will have more cash for unforseen situations or opportunities to buy assets at a cheaper prices.
Unfortunately, some of us have no choice but to cut down expenses because of the lower income received during this period. Please remember that this is only temporary. It will get better, eventually.
One may argue that because everyone is tightening their belts, recession then becomes a self fulfilling prophecy were less spending leads to less economic activity.
Well, your priority is to survive the recession first. Then you can worry about the recovery of the overall economy.
#2 Have a Shopping List
Your often see other financial blogs listing a few stock counters which they will be monitoring when recession hits.
I think it is a good idea. Prices tend to fall during recession so this presents a rare sale opportunity. So you should have a shopping list to monitor the prices of the items you would like to purchase.
My list extends beyond stocks – you could list down houses or other big ticket items that you have always wanted to buy.
However, to ensure that you are not buying compulsively you could set a target price to buy. For example, if prices fall below 20% then you buy it.
It is also important that you buy within your means. So you should have set aside that amount of cash needed.
For items where it is not feasible to buy with cash, like purchasing a house, you will have to take a loan. You should take up loans that is within your means. For housing in Singapore, you can check this rough guide.
#3 Investment Plan for Recession
Your general investment plan should have a section which details the steps you will take when your portfolio value drops due to market crashes.
The plan should always keep you focus on the long term goals and the objectives of your investment. Do not panic sell when you see your portfolio tank.
Always remind yourself that this is always temporary and prices will eventually recover when the economy recovers.
What are the guiding principles for you to rebalance or buy new assets? Check my previous article on rebalancing. The plan should detail those guiding principles. You should follow the plan and rebalance only when each asset drifts off a certain range of their allocation.
This will also be a good time to assess your risk profile. Does seeing your portfolio drop make you feel extremely nervous or worried? Then maybe your bond to equity ratio might be too agressive for you.
A market crash is a good time to re-evaluate your portfolio allocation and select one that is suited for you.
Boosting Your Portfolio
Sometimes, a market drop can be an opportunity for you to boost your portfolio. It is a rare opportunity where prices are lower which means they have more room to grow.
If you have some spare cash available and want to take advantage of the cheaper prices to boost your portfolio, your plan should detail the strategy: lump sum or dollar cost averaging.
An example could be: you split your cash into 1/3 and invest when the portfolio drops by 10%, 20%, 30% (This is just an example and not a guide. I just defined the numbers arbitrarily.)
Generally, we should avoid timing the market and try to buy at the lowest point because it is extremely difficult to do so.
If we try to time the market by moving our investments to cash during periods of high prices and moving the cash back to investments when the prices are lower, we might lose out on the top ten best days in the market which might lower our gains.
Hence, it is better to stay invested in the market at all times because of those reasons.
I would recommend setting aside more (by cutting your expenses) to invest during recession if you could afford to and stick to your regular contribution plan.
But only use cash that you will not need for the next few years. Your priority is your immediate living expenses so if you need the cash at hand more, do not invest it as your investments are likely to fall further during this period.
#4 Show Kindness
Showing kindness to others does not cost much and can go a long way in making someone’s day.
The recession will be a difficult time for everyone. So why make it harder?
This point might not benefit us financially but I feel that it contributes to overall wellbeing which is also important.
Conclusion: Plan For It and Be Flexible
There are no silver bullets for combating recessions. Any step that improves your financial situation better prepares you for a recession.
In the first section, I mentioned that it is important to prepare your safety nets, eliminate debt and up skill yourself. Having these three items is beneficial to your personal finance regardless of whether a recession happens or not.
In the second section, I mentioned that it is also important to have a plan of action during recession to help us make better decisions. Having a tighter budget, a shopping list and investment plan might help you make the best out of a bad situation.
It is also good to show some kindness to others during difficult times.
Lastly, your plans are meant to be updated. When the situations change, your plan should always adapt to your unique circumstances.
As the possibility of a recession looms over the horizon, do not be anxious but rather make preparations for it.
Maybe you might even profit from it.