Today I will teach you how to prepare for a recession. When I’ve looked up this topic in the past, all I could find was the obvious advice on how to weather the storm. No. No. No. I treat a recession as an opportunity to come out on top. And this requires early preparation.
First of all, if you’re researching how to prepare for a recession, you’ve probably seen some generic advice about having good finances like having an emergency fund. No duh.
But I’ll get very specific about what I’ll be doing with my own money leading up to a recession in steps 1-4 below. Then steps 5-9 may seem like familiar advice, but I break down exactly how to use them to your advantage either before or during a recession.
The truth is, no one knows when a recession is coming. Economists get it wrong more often than they get it right. But everyone can have a feel for when it’s close. It may seem boring to prepare for something that will happen who-knows-when but if you want to set yourself up to be SUPER opportunistic, it pays to prep and start early.
Think of it as investing in your ability to invest.
Adopt This Mentality Pre-Recession.
Again, I don’t want you to just weather the storm. I want you to take full advantage and come out on top. Here’s where your head should be:
- Understand that there will be a stock market crash so don’t be too aggressive as if it will never happen. You don’t have to be too safe, just not too aggressive.
- Make sure all your investing accounts are set up and working. We’ll cover what you need below.
- Make sure your finances are not bogged down by bad debts and bad credit, or even small details like not having all your IDs up to date. Making money moves requires someone to check your finances, so have your ducks in a row.
What is a Recession?
A recession is a significant decline in economic activity over an entire economy lasting several months. A recession’s consequences can be seen as a decreased GDP as well as other indicators like income, employment rates, sales, and production.
What Happens During a Recession?
During a recession stock prices tend to plummet, if only temporarily. Businesses may see less demand and less revenue, causing them to lay off workers to cut costs. This may lead to high unemployment numbers across multiple industries.
How to Prepare For a Recession in 9 Steps.
1 – Investing Asset Allocations.
This one will be tough mentally. Right before a recession the market will be high and getting higher. Since no one knows exactly when (or if) everything will drop, it’s incredibly tempting to keep riding the wave.
But as we seem to approach “late-cycle” make sure you’re not all-in on stocks anymore. You don’t have to sell everything, but just don’t be all-in. I talk about asset allocation during recessions in-depth in this market timing article and you can see step 3 about how to diversify.
There are some obvious and non-obvious reasons to not be too heavy in stocks when preparing for a recession.
- Stocks will take a big dive when the recession comes. It will be a painful gut-punch to see your assets go down in value if you haven’t researched how to prepare for a recession in advance. It may even push you to make the mistake of selling everything at low prices.
- There are non-timing reasons for pulling back on stocks too. It’s like having extra gas in the tank. A recession can feel like a fun stock buying opportunity rather than doom if you’re prepared. So make sure you have some cash for your stocks shopping spree when they’re at an all time low.
I’m telling you now, this will be incredibly hard. Everyone you know will be talking about some awesome returns they just got while you’re pulling away. You will suffer some serious FOMO and will question yourself. But you have to fight it.
Keep at least 30% of your money in something stable like bonds leading up to the recession and rest assured that for the people who went all-in on stocks – their glory days will soon turn to reproach. And you’ll be the one ready to pounce.
2 – Real Estate.
Leading up to the recession the markets will be high. When stock markets get hot, real estate markets do too. So there won’t be a lot of deals to take advantage of as you prepare.
But there are two important differences between stocks and real estate investing during market highs:
1. You can still find good deals.
Housing markets aren’t as efficient as stocks. People and robots all over the world can access the exact same stocks at the same time. There are no “deals” that you can spot before everyone else.
Buying a house requires you to be paying attention to a specific market and having some knowledge of what’s a good price. Essentially, there are fewer eyeballs. So if you find someone looking to sell quickly you just found yourself a deal.
2. Real estate investing is a long-term game.
If you can find a rental with a tenant that’s cash flow positive, buy it. If it’s cash flow positive, chances are it will be cash-flow positive forever. In the long-term, as you’ve paid down your mortgage and the rental rates have risen, your house will be VERY cash flow positive. Guaranteed.
So it’s fine if markets collapse, it’s even fine if your house value goes down. You’re just biding your time with your little cash flow machine.
While you’re figuring out how to prepare for a recession, I recommend you open a free account with Roofstock. They buy and sell rental properties. I don’t think you’ll find any good deals through them, but they will send you their listings in any area you choose so that you can start to get a feel for what is a good deal when you venture on your own.
What about cash flow negative houses?
Some investors are okay with cash flow negative houses (meaning their rent income is less than what they pay in mortgage and expenses) because they’re relying on the house’s appreciation as the investment.
This is okay in theory, as long as you know you can support the payments no matter what and won’t be forced to sell during a downturn. But I don’t think I could go for it. Too stressful.
3 – Diversify Your Investments.
Diversifying your investments means investing in several completely unrelated streams. Some streams will be a nice and stable place to park your money. Some streams will offer the perfect opportunity to buy. Some may face a dip in value, but it will all average out if it’s diversified.
Stocks are great.
Invest in indexes because individual stocks will be chaos. Yes, markets go up and down, but on average they grow 7-10% per year. Even if you go as far back as the great depression, the stock market was growing steadily on average.
If there’s a recession, you can take advantage by buying these index funds at a discount. But it won’t do you any good if you’re not prepared. Have an investing account and arm yourself with knowledge. (See point 4 about how to do this.)
Real estate is better.
Doesn’t matter what’s going on in the world, people will always need a place to live. Investing in real estate is long-term and buying a rental property is a perfect way to secure your financial future. Real estate is my secret sauce to financial freedom and I have a whole slew of resources on how to do this.
Farmland is best.
Investing in farmland is the best in how to prepare for a recession or high inflation. Farmland is completely uncorrelated to markets, and unlike gold, it pays dividends. Yeehaw!
By the way, you don’t have to go and buy a farm to invest in farmland. You can invest with an eREIT like AcreTrader which will use your contribution to invest in a farm. Their returns are the best I’ve seen (12% and up) and they’re a stable company that’s transparent in how they use your money. I have a whole page on farmland investing here.
4 – Automate Your Investing.
When a downturn hits, everyone will be freaking out, throwing around their advice and opinions about how to prepare for a recession. Right before a crash, there will certainly be mania. Some stocks will rocket to the moon, some will plummet. Insane volatility. Market options bought all over the place.
It’s hard not to get caught up. Worse yet, you might be distracted.
Years ago, when I was into stock picking, I was in the hospital for a few days. During those few days, the stock I had my eye on came down in price. It was the perfect time to buy, but my hands were tied. (This is before apps and free wi-fi were commonplace.) I don’t bother with stock picking anymore, but needless to say that at the time I was pretty peeved that I couldn’t buy my stocks at the perfect moment.
These days, I automate my investing and I couldn’t be happier. If your investments are automatic, your emotional state doesn’t matter and you get to ignore the noise. I set up regular deposits and rules about when to buy. Also, I only invest in index funds.
5 – Fill Up Your Emergency Fund.
Everyone knows about emergency funds and why they’re important. We learned that in high school. But having some backup money is extra crucial when asking how to prepare for a recession. It will keep you level-headed and help you not freak out.
The real issue is that you don’t want to sell off your investments during a downturn just because you need the money. Nothing’s worse than having to sell at a discount instead of buying at a discount.
If you have some safe money to live on, you can make aggressive investing decisions without getting attached or emotional.
6 – Pay Off Bad Debt.
Mortgages at good rates are fine, but almost everything else is usually bad. Credit cards, lines of credit, margin investment borrowing, even car loans and student debt are holding you back.
People tend to go debt-crazy near a recession, but I want you to face it unencumbered so that you can be opportunistic and maybe even leverage up.
If you pay off your bad debt, not only will you free up some cash to invest, you’ll also have good credit and will qualify for better mortgages. All of this will help you take advantage of the recession.
7 – Have Amazing Credit.
Having good credit is good advice anytime, but it’s especially important during a recession.
Usually, governments will slash borrowing interest rates during recessions. They do this to stimulate growth.
You want to be in a place to take advantage of this. Getting a low-interest loan or mortgage and using it to invest will help you come out on top. Have amazing credit, and you can get amazing loans.
Case in point, the 2008 housing crisis and recession had a lot of landlords default on their mortgages and declare bankruptcy. And when home prices went down, they couldn’t swoop in and take advantage. They’re only coming out of that haze now. That can be the difference between good credit and bad credit in how to prepare for a recession.
So what do you do? Pay off all loans aside from your mortgage. Pay your bills on time. Don’t carry a credit card balance, and have only one or two credit cards. (Don’t fall for the “get a free box of cookies if you apply for a credit card” scheme. Even that can impact your credit score.)
8 – Have a Stable Job.
If you’re not at a point where you can retire early with peace of mind, make sure you have a stable source of income through your job. Something that doesn’t fluctuate with markets or other people’s spending habits. You don’t need to worry about income when things hit the fan.
If you hate your job right now, make an action plan for switching jobs or even careers as soon as possible. Switching careers will be wildly harder when figuring out how to prepare for a recession, and most likely you won’t let yourself leave your current stability even if you hate it.
That means start investing in updating your skills now! Whether it’s technical skills, management skills, or getting a whole new degree – dive in now and don’t look back.
9 – Up Your Brain Game and Your Toolkit.
All of the steps above will set you up for success but they’ll do you no good if you’re:
- Running around like a headless chicken like everyone else.
- Playing defence when you could have been on the offence.
What do I mean by this?
Well, first of all, instead of figuring out how to prepare for a recession everyone will be stressed out – mostly from watching the news and being told to be stressed out. No one you know will be taking action – only complaining. Don’t let yourself get sucked in.
Stay mentally strong, and remind yourself that not only can you handle this, you can come out on top.
But that means that you have to be ready to be opportunistic. Arm yourself with tools and knowledge now. Set up your stock investing account, your farmland investing account, educate yourself on real estate. That way, when a recession hits, you’ll be one step ahead.
Here are some resources:
- For investing in stocks, set up an account with M1 Finance. They have the lowest fees and offer the most straight-forward automation. (Read my reviews here.)
- For farmland investing, I recommend an AcreTrader account but you have to be an accredited investor. (Read my review here)
- To get familiar with real estate – well that’s kind of my forte, just dive into my real estate articles.
- Set up a free account with Roofstock (the platform that buys and sells rental properties) to start getting an idea of how much houses cost and how much they rent for. (Read my review and strategy for Roofstock here.)
TL;DR – How to Prepare for a Recession
- Set yourself up to invest when the markets are low. Make sure you have cash to work with.
- Have clean finances: good credit score, no debts, steady income
- Set up and automate your investment accounts, and diversify your investments
- Don’t be all in on stocks right before a recession – give yourself wiggle room to buy them when they’re cheap.