There is a financial playbook for navigating the next recession.
Worries about looming economic rough patches have been heating up in recent weeks as the bond market, as recently as Thursday, flashed a recession warning sign with the 2-year Treasury yield moving above the 10-year Treasury yield (^TNX). Known as an inverted yield curve, this dynamic has historically preceded past recessions. While the yield curve inversions over the past week have been brief, financial advisors who spoke to Yahoo Finance have been fielding extra questions from clients on how to financially maneuver the next recession.
The dangers of deviating from a long-term financial plan
And the playbook is rather simple. In fact, if you have a long-term financial plan in place already, a recession shouldn’t push you to make major changes. That’s the assessment from Melissa Weisz, a wealth advisor with RegentAtlantic, based in New Jersey.
“We want to avoid making major changes to a long-term plan,” she said.
While some investors tend to sell stocks in the event of a recession, Weisz said de-risking your portfolio to prepare for a recession-driven market downturn can introduce a new risk: bad timing.
“If we’re being humble, no one has a crystal ball. We don’t know how the market would respond to a recession and by the time the recession comes, the market may be timing in a recovery,” she said, referring to the forward-looking nature of the stock market.
Trying to time the stock market can lead to one of the worst financial strategies: selling stocks when they are low and buying them when they are high.
Cash is king, especially in a recession
In the short-term, there are ways to prepare for the day-to-day trouble a recession can bring. Experts agree consumers should take steps to raise the amount of cash in their emergency savings fund. And for those who don’t have an emergency fund, start building one.
“This is your first line of protection,” said Jim Marrocco, founder of Thinking Big Financial, a New York–based financial advisory firm. “A recession might mean less job security. It’s ideal to have at least 6-months worth of expenses set aside in cash.”
Asset location vs. asset allocation
While financial experts tend to stress the importance of asset allocation — that is, how much of your total portfolio is allocated in different asset classes, such as stocks, bonds and gold — there’s another financial phrase that takes on extra importance in a recession: asset location.
For Weisz, asset location means knowing which accounts to draw from in case you need money. For example, a Roth IRA, which is a tax sheltered retirement account, should be the last account you take money out of, she said.
“A Roth IRA is long-term money. It’s tax free growth — it should be the last asset you touch,” she added. “If you need money, know which account to pull from first.”
Marrocco echoes this point and urges investors to tap the bond portion of their portfolio before the stock portion, as a market downturn in a recession could take years to recover. Depleting your stock portfolio after a market downturn provides no opportunity to participate in the market’s eventual rebound.
“The stock market selloff towards the end of 2018 happened swiftly, but the market also came back quickly,” he said. “That might not always be the best example. The market may fall 20-30% in the next recession, but we don’t know how long it will take to come back.”
On December 24, 2018, the S&P 500 (^GSPC) was down 19.8% from its September 2018 peak. By late April of 2018, only four months later, the S&P 500 had eclipsed its September 2018 peak. The December selloff wasn’t sparked by recession fears or an inverted yield curve, but more so on fears the Federal Reserve was raising interest rates too quickly.
Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.
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