Is This the Next Recession? What to Know (and Do)

SMART INSIGHTS FROM PROFESSIONAL ADVISERS

Is This the Next Recession? What to Know (and Do) About It

If worries about whether a bear market is around the corner are keeping you up at night, here's what you should do right now ... and more importantly, what you should NOT do.

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It would be hard to miss all the media coverage that’s been going around lately about “the next recession.” It seems that the implication is that a potential recession is this big, looming thing that’s about to happen ... and we’re all in big trouble when it finally strikes.

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But most headlines present an emotionally charged take on this topic, which doesn’t benefit you as an investor who wants to grow and keep wealth. So let’s take a step back from all the noise and the emotion-driven conversations and focus on a few key facts:

  • We don’t know with certainty when the next recession will start.
  • We don’t know exactly how much it might impact the market or economy.
  • We don’t know precisely when it will end and a new expansion will begin.

Looking at that, you might feel like I’m suggesting we don’t know much. That’s not too far from the truth! When it comes to predicting what’s next in financial markets, they are just that: predictions. Guesses. Unknowns.

What we do know is that:

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  • Recessions are normal parts of market cycles and should be expected.
  • Market volatility is also normal, and also to be expected.
  • Market timing doesn’t work … but investing for the long term with a diversified portfolio appropriately allocated to your goals, needs, and time horizon can work very well.

How can this information help you? You can take a closer look at these facts to ground yourself in reality and then make better, more informed, and reason-driven decisions around what to do with your investments when a recession seems imminent.

Here’s Why Worrying About What the Market Will Do Tomorrow Is a Waste of Energy

I just stated that no one can predict with a high degree of accuracy what will happen next. That’s true — but this time it is a little tricky. Why? Because we’ve been experiencing a very long bull market, where the value of equities has gone up. And up. And up. It seems rational to think, “OK, then we have to go into a bear market soon. We have to face a recession; it’s just inevitable because what goes up must come down.”

There’s some truth to this, too. The market will experience a contraction or a downturn — eventually. But again, we don’t know when, we don’t know how long it will last, and we don’t know how severe it will be.

To prove this point a bit, consider that in 2018, a CNN Money article reported that 58% of investors thought the bull market was on its last legs. But on the whole, the S&P 500 continued moving higher in 2018 and into 2019. We did experience a lot of volatility throughout 2018 and 2019, but if you look at Google’s Market Summary for this index, you can see two important things:

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  1. As of August 2019, the S&P is up more than it was when the year started.
  2. Perhaps more interesting is the fact that in August 2019, the S&P was also right about the same place it was a year prior, in August 2018.

Think about all the emotions you’ve felt about the market and your investments over the last year. I’m sure you experienced various different feelings, from fear to some excitement and everything in between — but you rode that roller coaster all over the place just to have the market essentially wind up in the exact same place it was 365 days ago.

If you only have this week to invest money, you have a pretty good chance of walking away with a loss. But if you have 20 years, history shows that there are no rolling 20-year periods where the market averaged a negative return. That includes periods of time with big crashes like 2008 — meaning, even if 2007 and 2008 are years on your timeline, you still have a positive average return (assuming you stayed invested and didn’t jump out of your seat to sell and move to cash).

This is why time in the market matters. Not timing the market, but time in the market.

A Recession Is a Normal Part of the Economy, Not the End of the World

Speaking of 2008, this could be a big reason that everyone is extremely fearful of experiencing another recession soon. The last one we experienced was called The Great Recession because it was the worst downturn since the Great Depression.

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Because humans suffer from recency bias, where we tend to think whatever just happened is likely to continue to happen the same way into the future, it’s easy to hear “recession” and have that mean something very specific, because that was the last experience we had with that word.

It’s important to remember the last recession we experienced was not normal, although recessions themselves are normal parts of the economic cycle and something we can expect to happen every once in awhile. It might also help to know a recession is not some big scary monster; it’s defined as “a significant decline in economic activity.”

No one is saying this is a great thing, and hard times could still lie ahead — but we need to keep things in perspective and not catastrophize what might happen next. Here’s what normal recessions tend to look like:

  • According to the National Bureau of Economic Research, recessions since World War II have lasted, on average, about 11 months each.
  • That figure was skewed longer by the Great Recession, which lasted for 18 months after starting in late 2007 with the bursting of the housing bubble and resulting financial crisis.
  • There are more bull markets than bear markets. There have only been eight bear markets since 1926. And since 1926, the annual U.S. stock market return has been negative only 26% of the time. So 74% of the time, it’s been a positive return.

Even if we hit a recession right now, almost all of us have time to ride out a period of 11 months of not-so-great market performance (and that includes you if you are closer to retirement than not, but we’ll get to that in a moment). What none of us can afford to do is try and time the market to avoid the worst of the lull in economic activity that might pull the values of our investment portfolios down temporarily.

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What You Must Understand About Market Timing

Even when you know all this, it’s tough not to feel tempted by market timing. Market timing is when you actively try to avoid investing during the worst times in the market and only invest during the best. If you’re wondering if you should move to cash right now, for example, you’re flirting with market timing.

There are so many issues with this, but one of the biggest might be the fact that everyone — from world-class economists to your loud-mouthed co-worker who thinks he knows everything — is really bad at predicting recessions. A 2018 study conducted by economists at the International Monetary Fund looked at 153 recessions in 63 countries between 1992 and 2014. Economists in both the public and private sectors missed most of them.

In fact, even the Great Recession wasn’t actually declared a recession at all until a year after it started! But let’s say you are different and special and can magically predict the beginning of a recession when no one else can. You still face a problem: You have to get it right twice, because you’d also have to predict when the recession will end, which decreases your odds of success.

Anyone can get lucky once or twice, but this is almost impossible to do consistently. You have to move to cash before the market tanks so you don’t sell low, and you have to buy back in before the market actually recovers so you don’t buy high. What happens to most people who do this? They tend to wait until after the bottom of the cycle — until after assets already hit their lowest points — to sell. Then they usually don’t work up the nerve to jump back in until after the market already has recovered.

This is one of the worst, most expensive and damaging mistakes you can make with your investment portfolio. Which is a shame, considering it’s so easy to avoid: Stay in your seat. Don’t try to time the market. Stay the course and stick to your strategy, because now is not the time to start tinkering with your portfolio.

What to Do: Control the Things You Can Control

Ultimately, the market is not something you can control. Obsessing over what to do with your investments to recession-proof them doesn’t make much sense … but what might be a good idea to focus on is your own personal finances.

If you are severely worried about a recession to the point you’re extremely stressed or losing sleep, turn your attention from your investment portfolio. Some things you can focus on instead:

  • Your expenses. If you’re truly scared of a recession, pull out your budget and start trimming costs now. Bank the money you don’t spend into something like a high-yield savings account to build your emergency fund.
  • Your debt. If you have high-interest rate debt, start attacking it aggressively to get rid of it ASAP. This will also require you to focus on your expenses and reduce your spending so you can free up money to use to get rid of your debt.
  • Your big purchases. Avoid any huge, major purchases right now that are non-essential. If you strongly believe that a recession is around the corner, hold off on buying that boat or upgrading to the big house that will push your cash flow to the limit. That doesn’t mean you have to put your plans on hold — just spend a little more time saving up for these big purchases. This might help you feel less threatened by the idea of a recession, and it will just leave you with more cash available to make a big or luxury spend in a year or two once you feel more confident about the economic climate.
  • Your skills and marketability. You can also focus on making sure you personally are marketable. Is your résumé up to date? Is there a skillset you want to work on or develop? A recession could mean upheaval with employment and jobs might not be as plentiful as they are right now, so make sure you’re prepared to look for a new position if you need to.

None of this means you have to make drastic, life-changing moves. Just look for ways to cut back on spending to boost your savings or the cash you have on hand. This is hard work, but it can give you a lot more peace of mind that you’re prepared to weather the temporary storm a recession can cause in your personal life.

The Bottom Line on Dealing with Your Investments When Markets Are Turbulent

We do a pretty good job of educating clients about the market, and for the most part, we haven't actually been getting a lot of folks reaching out and asking questions — because they know to expect market volatility, and they understand what's happening.

The clients who have reached out to ask questions are generally asking things like, "Should we change our investment strategy?" because of the recent wobbles we've seen in the markets.

We answer that by explaining the strategy we set is one that's designed to work over the long term — meaning that these short-term market movements should not cause us to change course. This is actually where most investors get into trouble; they see something happen right now and try to react to it, rather than simply staying the course.

We also want to acknowledge that we understand experiencing the volatility (and the drops) in the immediate term is not an enjoyable experience. But we have to take a broader view and consider not what the stock market is doing day to day, but what it is doing on a 10-year (or longer) time horizon ... especially for retirement accounts.

Corrections are normal parts of market cycles. For younger, long-term investors, these drops can provide an opportunity: As you continue to contribute through these drops, you're actually buying into investments for a lower cost. You might hear some people say corrections or downturns are really just "stocks being on sale," and there's some truth to that when you’re contributing to your investments, not withdrawing from them.

Even our older clients (who range between older Gen X and Baby Boomers) need to remember that, assuming they live to age 90 or longer, they still need their investments working for them for 20, 30 or more years. While they might not be "long-term investors" in the same way someone who is 20 or 30 might be, they would still benefit from not panicking or trying to move to cash. We already know the dangers of market timing.

The bottom line is that the investment strategy you choose should be designed to weather short-term volatility to provide you with a better chance of long-term success. Right now, both for myself and for my clients, we're looking to stay the course and hold to our strategy because we chose it knowing that dips and corrections like a potential recession will happen along the way.

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Eric Roberge, CFP, is the founder of Beyond Your Hammock, a virtual financial planning firm that helps professionals in their 30s and 40s make mindful decisions with their money and strategically use their incomes to achieve financial freedom.

Eric is one of Investopedia's Top 100 most influential financial advisers and is a member of "Investment News' " exclusive 40 Under 40 class of 2016.

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