Preparing For The Next Recession

October 29th, 2018
12

The current bull market is over 9.5 years old, one of the longest on record.

I’ve frequently written about how you cannot predict when the current bull market will end. Investors have been predicting the end of the current bull market every year since it began in 2009. Those who pulled out of the market early missed out on significant gains in the stock market.

But I’m not saying that the bull market will continue on forever. All bull markets one day come to an end, and we will eventually have a recession. We just don’t know when. And there is significant reason to be pessimistic about the U.S. economy, as there always is.

The Probability of a U.S. Recession by The End of Trump’s First Term

I’m a big believer in prediction markets to forecast future events, whether it is the outcome of a sporting event, the victor in a political election, or the probability of a future recession.

The website PredictIt has a prediction market where participants can bet on the probability of a recession by the end of President Trump’s first-term (most likely 2020, but there’s actually a 25% probability that Trump will not be president at the end of 2019).

The current probability (as of October 29, 2018) that there will be a recession by the end of President Trump’s first term is 56%.

According to the PredictIt prediction market (as of October 29, 2018), the probability of a recession by the end of President Trump's first term is 56%. Click To Tweet

So, while we may not know when exactly the next recession will occur, you should always be prepared, whether it occurs next year or in 10 years.

Preparing For The Next Recession

Here are three steps you can take to be prepared for the upcoming recession:

Assess your asset allocation

Take a hard look at your asset allocation and see whether you are able to handle the risk associated with that portfolio allocation.

Most investors tend to be overconfident in their ability to tolerate risk when the stock market is rising, especially if they’ve never experienced a bear market.

If you think that you need to reduce your 90% stock portfolio to 80% or 75% stocks, it’s important to do so now before the next recession occurs. The worst thing you can do is go from 90% stocks to 0% stocks when the stock market is falling and the next recession is occurring.

Adequately be saving for retirement

As a general rule, you should be saving 20-25% of your gross income for retirement.

When the stock market is rising, people can get complacent in saving for retirement. After all, when the stock market is rising 10-12% per year, it can seem like you’re way ahead in your retirement savings.

But if the stock market falls and you’re inadequately saving for retirement, you can quickly fall behind in your retirement savings. Saving 20-25% of your gross income for your 30-35 year career gives you a high probability that you will have saved enough for retirement, taking into account scenarios where the stock market performs better than average or worse than average during your career.

Consider holding an emergency fund

Most attending physicians do not technically need an emergency fund. If there is a financial emergency, you can usually liquidate investments to pay for short-term bills. And since financial emergencies happen relatively infrequently, the money will grow faster in the stock market than in a checking account.

But financial decisions don’t always have to be about the math. Personal finance is just as much about psychology as it is about optimizing your money. If the peace of mind of having 3-6 months of expenses sitting in a safe checking account, immune from the ups and downs of the global economy, makes you sleep better at night, then an emergency fund makes a lot of sense.

Always be prepared for a recession: Create an investor policy statement

An investor policy statement is one of the best things you can do to be prepared for a recession.

An investor policy statement puts down in writing your investing game plan. It typically includes your investment goals, risk tolerance, and asset allocation. It also can contain written directives for how you will react to certain scenarios, such as a recession or bear market.

If you have no idea where to start with your investor policy statement, a financial advisor can help you make a financial plan. They can also help you stay accountable to your investment policy statement so that you stick with it during recessions.

However, making an investor policy statement shouldn’t be complicated — White Coat Investor has a course that can guide you, step-by-step, through making your own investor policy statement, at a fraction of the cost of having a professional write one for you.

And if you just want a few templates to help you write your investment policy statement, here’s a great post on the Bogleheads Wiki to get you started.

Once you have an investor policy statement, you need to follow it. Read it whenever you have the urge to sell your stocks after a big drop in the stock market. It can help provide clarity in your decision-making when there is chaos in the financial markets. As a result, you’ll be more likely to stay the course, which is critical for your investment success.

Conclusion

The probability of a recession by the end of Donald Trump’s first term as president is over 50%. This shouldn’t be cause for you to sell your stocks. Rather, it should prompt you to assess your asset allocation, ensure you are saving enough for retirement, and consider building up an emergency fund. Most importantly, you should have an investment policy statement that you can refer to when the next recession finally does occur.

What do you think? Do you think the probability of a recession by 2020 is greater than 50%? How are you preparing (if at all) for the next recession?

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12 COMMENTS

  1. Solid advice.
    I have decreased my stocks down to 30-40% I’m not generally recommending that mind you, I just know how I feel during stock crashes. I remember at least three of them distinctly.
    I don’t time the market, but I also don’t completely ignore all aspects of valuation by assuming a blind faith in upward progress forever.

  3. Our equities are nearly 100% stocks but we have a Smaug sized cash hoard waiting to be spent on a house. All the invested dollars are ear marked for retirement and are not needed anytime soon.

    Our equities might be aggressive but our overall portfolio is quite conservative

    I dont think we will change our asset allocation and will just ride out the coming storm.

    I am intensely curious how I will feel during the next recession.

  4. An investment policy statement is key, in good times or bad.

    It prevents you from chasing the market or from doing a rapid sell off with market declines and locking in losses.

    Based on a combination of my IPS and my excel spreadsheet (which has the % allocation I want for each stock) it is a simple plug & play of numbers that tells me what I should do with 1 asset or another.

    Even if you think there is a high chance of a market recession, really shouldn’t change stock % against your IPS because that is in essence you trying to time the market which in the long run is never a good thing. Always think long term (unless you are 5 years out from needing the money and then your IPS should have you on a glide path down in equity % anyway)

    • I use Hulk Investor as my analogy. I started gently changing my allocation to have more fixed income over the past year or two. Not because I can time the market, but because I can feel my risk tolerance shrinking as I age. I don’t want my inner emotional Hulk to take over and smash my portfolio leaving me nothing but torn purple jean shorts.

  6. I think doctors do need to keep and emergency fund. Too many doctors get into trouble because they do not have any money/cash in reserve. You can’t believe what some doctors consider emergencies. Better to be prepared and not use the credit card for emergencies.

    Dr. Cory S. Fawcett
    Prescription for Financial Success

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