Should you have a recession strategy?

Should you have a recession strategy?

I’m going to keep my thoughts short this month, but I think its important to address some recession concerns many investors currently have in today’s markets. The financial media has been promoting the next “looming recession” for years now, but there is some recent cause for concern because of the inversion of the yield curve, trade war, and slowing economic growth in many sectors. In the past, the inversion of the 2-10 year yield curve (long-term bonds have lower yields than short term bonds) has preceded most recessions by 18 months or less.

A recession is defined as two consecutive quarters of decline in Gross Domestic Product (GDP) growth. The key point here is that a recession is defined retroactively. It’s impossible to actually know you’re in one until months or even years later. In December 2018, the market fell by about 20%. Many investors and folks in the financial media were sure we were entering a recession. However, GDP growth was still strong, and the market bounced right back in January. The worst possible thing you could have done was to sell your stock and move to cash in December of last year.

In a previous article, I discussed how a friend of mine sold out of the market in 2008 and came back in 2011, and sustained massive losses in both capital appreciation and dividend return in the process. The best course of action back then is the same as it is today. Don’t ever sell. Timing the market is always difficult, and its even more difficult in an extremely high volatility bear market.

So if its never a good idea to have a recession-specific strategy, does that mean your financial planner should do nothing when there is obvious signs of potential recession in the future? Certainly not. With my clients I always have discussion on risk tolerance and rebalancing portfolios to better reflect their own ability to withstand market upheaval. In other words, a “recession strategy” is to ensure that your allocation of assets is appropriate for much risk you’re willing to take, and your ability to hold your position without selling. Its very easy for most of my clients to say “I can hold” a 100% stock portfolio through a major recession, but the reality might be very different. A diversified portfolio of stock, bonds, and real estate can reduce risk without sacrificing much return, and make it much more likely for that person to not panic during an extended downturn.

So what is a good recession strategy? Evaluate your risk tolerance, allocation, and emotional ability to withstand losses BEFORE a recession, so that when it happens, you’re adequately able to deal with the results. As the market struggles, your portfolio is going to continue to reinvest dividends and build up more shares, so that when the market eventually recovers you’ll be on your way to be a much wealthier person.