What should your investment priorities be?
I love snow — not the powder-lining you might long for on an overpriced ski slope, but the simple, white stuff that blankets the neighborhood. Our neighbors and friends all think I'm crazy, with the possible exception of the five or six families that happen to live on either side of us whose sidewalks get shoveled for no other reason than my exuberance for exercising out in the wondrous white weather. Is it because I spent the first 50 years of my life in areas where the sun always shines? Who knows; but when we moved to Colorado, one of our good friends predicted swift disillusionment: “They who see the stars in it, have never pushed their cars in it.” Well, it has been 11 years and the snow stars still shine brightly for me, as you can see from this picture, taken from our front door.
Whenever my wife, ever the quick-witted one in the household, hears me wax on about the white wonder of winter, she never fails to dryly add that those stars glisten much brighter from within a well-warmed house. That is quite true, of course. I am certain that one's view and how one experiences winter depends very much on the vantage point from which it is viewed — trying to survive a blizzard when your car breaks down versus sipping pina coladas in Cancun or the Bahamas, for example.
It's true for many situations in life: Whether something portends problems or prosperity depends very much on where you are situated. It is especially true for the economy.
The economy goes up and down in cycles, as we know. What fewer people know, however, is how predictable — and short — those cycles typically are. Since World War II (almost 60 years, a period covering most readers' lifetimes), America has had 10 recessions. In recent times, we have had a recession every seven to 10 years, as shown in this chart:
The last recession bottom happened in 2009, and you don't need to be a math major to figure out that it won't be too long before the economy hits the skids again. When that will happen exactly, nobody can tell; but if the past is any indication, it will be soon.
How should you approach this time?
1. Expect it. I don't know about you, but when I was younger, every recession took me by surprise. I know I'm not the only one. The main reason for that is the suddenness and severity of the change. On the other hand, when the economy recovers, it does so slowly and gradually, giving you plenty of warning that it is improving. In fact, when I tell people today that the economy has recovered from the Great Recession (which bottomed out almost six years ago) many still push back and say, “No way!” It's only when I ask them if they are better off today than, say, three years ago that they grudgingly concede that, yes, indeed things have been improving ever so gradually.
That creates an unwritten expectation in us that an economic reversal should also happen slowly and gradually; but, unfortunately, that never happens. It is usually a single day, with a dramatic drop in the Dow, which precipitates mass angst and panic. Within a month, like a virus, that panic spreads to the mass-printing of pink slips, and it's not more than a few short months before Jay Leno starts making recession jokes. (Well, at least when he was on the air, he did.) It is easy to make light of it, but the trauma which befell the 10 million people who lost their homes and/or had to endure the humiliating devastation of filing personal bankruptcy are not funny.
Fortunately, most of the time that pain is avoidable. The first thing to do is simply to expect it and not be rattled or flustered when it happens.
2. Delay all non-essential purchases. The second thing to do is freeze all major purchases, same as you did in the last recession. Few like to admit it, but these days the notion that it is okay to splurge a little (or a lot) has quietly crept into society again. The Great Recession is a fading memory, and neighbors, family and friends are stepping out, so it's only human to wonder if you could join the party. After all, how long should you have to keep sucking it in? Chances are that things are looking better at work than they have in a long time. Perhaps you just got a raise (or at least got previous cuts reinstated) and maybe even the odd bonus. That all adds up to the feeling that now is the perfect time to finally get that new living room set, GoPro camera, or HD television. Hey, I was tempted to get a camera drone for Christmas, myself. They're only $600, after all!
Don't. If you can be patient, you'll be able to pick those up for 30 to 40 percent off in the coming recession, after you find out how your job situation shakes out.
The biggest item of all is a new home. By far the majority of victims of the previous recession were people who bought their homes close to the top of the market and then lost their jobs unexpectedly. (And isn't a job loss always unexpected?) It's not going to be much longer. Just wait.
3. Top off that emergency fund. You may not lose your job — in fact, less than 10 percent of all workers lose their jobs even in the toughest recessions — but you may feel an impact in other ways such as a cut in pay, hours or benefits, canceled vacations or bonuses, or even the extra workload that comes as other coworkers are laid off. You get the picture. A lot has been written about emergency funds here and elsewhere, so there is no need to beat a dead horse necessarily. The point is that, if you have been procrastinating on this issue, it's time to get serious again and increase your savings now.
4. Get rid of debt. To the readers of Get Rich Slowly, this isn't anything new or earth-shattering. However, if by chance you snuck in a little credit card balance, now is the time to take it out and shoot it. If you can swing it, it is also a good time to make a few extra payments on that car, home or student loan. Any payment you make now could give you breathing room when you need it most. It's like putting sandbags around your home to protect against a possible flood.
Why all the frugality at a time when the economy is in the best shape in years? It's so you can …
1. Don't sell. Most people invest through their 401(k) plans at work or other tax-advantaged opportunities like IRAs. Some have investments in other assets like rental property. In the coming recession, the value of those nest eggs will drop significantly. By now, that should not be a surprise. The important thing is not to panic and sell. According to the Investment Company Institute, this is when most mutual fund investors sell — which is a huge mistake. Mutual fund prices recover pretty much like the chart of the economy above. Just as those values now are much higher than in 2009, they will rise again after the next drop.
The only thing you need to benefit from that next recovery is the determination not to sell. Psychologically, it may be hard not to run for cover when the bombs go off around you. That is why it is valuable to be forewarned, so you can tell yourself ahead of time what to expect and what (not) to do.
But what if you are about to retire? Shouldn't you sell now to lock in your gains? The answer is “No,” and here is why: Even in retirement, you are planning for a horizon longer than 10 years. That means your investments will come back before you need them. Nobody uses their entire retirement fund in a year … or even in five years. You might consider selling a small portion of your portfolio to cover your expenses for the next three to five years — or, better yet, convert your portfolio to dividend-paying stocks and fixed-income securities (or mutual funds which invest in those vehicles). If you live from your dividends (or interest), you don't need to sell hardly any of your investments, and they will recover in the next recovery, just like everyone else's. Will those dividends dry up in a recession? Not necessarily: there is a group of stocks known as Dividend Aristocrats, whose dividends have increased for 25 years or more, without any interruption. Investing in those (or a mutual fund that invests in them) will ensure that your dividends keep growing, even in hard times.
2. Buy. In a recession, prices of everything are at their low point. That makes it the best time to buy … and, therefore, to keep investing. In fact, if you have spare money lying around, that is the time to buy things like rental homes, stocks, mutual funds, etc.
The time to sock away that spare money is now, while things are a lot easier than they will be when you want to buy.
But what about now, while prices are still close to a cyclical high? Should you still keep buying? Surprisingly, the answer is “Yes,” especially if (like most people) you do your investing through an employer-sponsored retirement plan like a 401(k) fund. Every month you don't invest is a lost month, and besides, history tells us that, even when the market falls, it always comes back to a higher level. Likewise, if you invest in something like an IRA, those are limited by calendar years — if you miss a given year's contribution, you can never make it up.
On the other hand, if you are considering buying a rental property, you might want to think twice, as those prices are likely to be significantly lower in the coming recession.
So, in answer to the question in the headline, the priority for investing is to get prepared for the stormy weather that is not too far in the future. Nobody can ever tell for sure when the storm will hit, but being prepared early beats getting caught before your preparation is complete.
You know the saying: “Make hay while the sun shines.” Well, the sun is still shining, but it is late afternoon and the time to make hay might be coming to an end.
What are your investment priorities?