Winter is coming, do you have a financial plan?
Mitchell Barr, Client Associate
Note: There are spoilers from the popular HBO series Game of Thrones in this article.
With all the wisdom of Ned Stark, I will say it: Winter is coming! By “winter,” I’m referring to the dirty word that no one wants to talk about. Recession. Like those crazy northerners in Winterfell, we don’t know exactly when, but it is coming. Right now, we are in a long summer, almost a decade of economic expansion. It’s been so long since the last recession that younger people just entering the workforce and making their first investments have never experienced one.
The tricky thing about recessions is that no one has developed a way to accurately predict them. They are, however, inevitable, so we should be prepared before they occur and we get gobbled up by the White Walkers. To avoid this terrible fate, we need to be one step ahead of the game. We need to be …Tyrion Lannister. For those of you not familiar, Tyrion (Peter Dinklage) is half the size of a typical man. In spite of his size, he always finds a way to survive because he plans. He is the epitome of brains over brawn. How can we become Tyrion and plan for a recession?
Prepare for loss of income
Whether you are working or retired, there is always the possibility you will lose some of your income in a recession. If you are employed, you suddenly may not be. If you are retired, your investments may perform poorly and force you to reduce your withdrawals (I know this is difficult to comprehend). The first defense against this is a cash reserve, which means you have to save money. The last thing you will want to do during tough economic times is compromise your lifestyle because your income has dried up quicker than the sword dropped on Ned Stark (Sorry had to do it).
If you’re currently working, set up a transfer every month to your savings account until you have three to six months of expenses, and then forget about it until you need it. Open up a separate bank account if you need to so in your mind it feels like a separate bucket. For retirees, think about A) a conservative withdrawal rate; or B) a flexible withdrawal strategy that allows you to take out more money when times are good and less when times are bad. Withdrawing too much money from your portfolio during a down year is like kicking it in the ribs after it just got punched in the mouth.
Don’t borrow too much
Because he is a Lannister, Tyrion not only plans, he always pays his debts. Sure, his family is wealthy, but he also doesn’t borrow more than he can repay. The last thing you want during a recession is to owe the Iron Bank more than what you are worth. Chances are your net worth will drop in a recession. Your house and investments may fall in value, but those debts aren’t going anywhere. Not having an income to pay your debts or having to sell investments to do so is a recipe for disaster. Keeping debt manageable will give you the capacity to borrow during a recession if you need to replace lost income. This can be an invaluable tool to augment your rainy day fund and bridge gaps in income.
Diversify your investments and stay the course
It takes an army of investments to weather a recession. Your portfolio will suffer casualties, but not all types of investments perform poorly during bad economic times. There are certain types of investments that aren’t affected by economic performance, such as reinsurance. An example of this would be providing insurance against weather-related perils like hurricanes. People in Florida still need hurricane insurance when the stock market is down. Other types of investments, such as treasury bonds, may also benefit in some recession scenarios from other people fleeing to “quality” when their stocks decline in value.
In the economic Game of Thrones, having a diversified portfolio can keep your army charging ahead when your frontline defenses are crumbling. All the different investments are your bannermen. You need to have them before the war starts. That way when all hell breaks loose, you know you are not alone. Investment markets often anticipate economic outcome or changes six months or more before the actual event. If you wait for the National Bureau of Economic Research (NBER) to declare that the economy is in recession, the horse has already left the barn in the investment markets. People often struggle with hanging on to investments with lower expected returns like bonds and gold when the stock market is doing well, and then flood into them during recessions after all the money has been made. Worse yet, they sell investments when they are down out of fear, which is the exact opposite of what you should do if you want to make money. Buy low and sell high, remember?
You should have a strategic plan to win the war so that you aren’t tempted to make emotional decisions, which could be deciding on a long-term portfolio allocation and sticking to it. If you decide that your long-term portfolio allocation is 50% stocks and 50% bonds, your only trading activity should be to get back to that target. More importantly, don’t let your ego get in the way and betray your carefully crafted battle plan once the war starts! We don’t want to end up like Rob Stark (also sorry about this one).
Win the Iron Throne
It could be a month or many years until we enter another recession, so don’t interpret this article as senseless fear mongering. It’s simply a reminder that we as humans are very adept at focusing on recent events and having a fuzzy memory of the past. Yet, all of this preparation will hopefully lead you to your own Iron Throne: your goals. Be a step ahead of the game, always pay your debts, and stand by your army. If you do, when Winter comes, and you are prepared, you can coolly explain, “That’s what I do. I drink, and I know things.”
Mitch writes the popular blog, The Money Monkey, where he focuses on common mental mistakes made by investors, how to avoid being your own worst financial enemy, and thinking about investing in new ways.