Jeran Van Alfen, CFP®
Financial Planning for a Recession
As we wind down 2022 and evaluate the current financial conditions, here are some things that are on our mind and adjustments that you may want to consider when it comes to your financial plan.
This year has brought change that many of us as investors have not experienced for quite a while. Over the last 3 previous years, we got used to comfortable stock market returns and that great feeling that we get when we see our statement balances go up. In 2019, large U.S. stocks returned 31%, then followed up in 2020 and 2021 with 18% and 29% respectively (and that was during a global pandemic). This year the momentum changed and for most of the year stocks have been down double digits.
I think it is important to acknowledge what conditions are driving change and set expectations for the road ahead.
Did you know that since 2009, the Fed Funds rate has averaged 0.6%? Similarly, during this time the 10-year treasury yield has averaged 2.3%.1 It is no secret that interest rates have been really, really low for a really, really long time. Because the government has been stimulating our economy for so long, as investors we have become accustomed to a situation where there hasn’t been a compelling alternative to stock market returns.
This has changed.
Interest rates haven’t been as high as they are now since before the iPhone existed and we are in a situation where we may receive some compelling returns for fixed income assets like cash and bonds.
Recession indicators are flashing
One of the most reliable economic indicators of a looming recession is an inverted yield curve. This is when the yield on a 10-year treasury bond is less than the yield on a 3-month treasury bill. Right now, we are experiencing this yield curve inversion and it has ramped up the expectations of recession.
Source: Blackrock Student of the Market. November 2022
Disruption and a Changing Regime
Over the last 40 years, globalization has contributed to a period of low inflation and somewhat steady growth. The pandemic accentuated production constraints that are leading to massive changes. Here are some key factors leading us to expect a new regime of higher inflation, interest rates and volatility:
Persistent geopolitical tension is leading to changes in global supply chains
Changes in energy demand and production along with a transition to net-zero carbon emissions
Disruptive medical technology is leading to aging populations leading to worker shortages
Central banks can’t resolve these issues, they can only influence demand. Monetary policy is aggressively taking action that may lead to recession.
The author Jack Canfield teaches a formula for success: Event + Response = Outcome
What this means is that it is your response, not the event itself that determines your outcome. This applies to our financial plan because the direction of the economy, geopolitical issues and the movement of the markets are completely out of our control. However, we can take action to influence the outcome that we experience for our financial goals. Here are the 5 time-tested fundamentals to remember right now:
1. Know how much you are spending on non-essentials. I call these expenses your lifestyle expenses. This is the spending you do to live a high-quality life but could be cut down if needed. I recommend limiting lifestyle spending to 30% of your monthly net income. (Here is what I normally include as essential expenses: housing, food, utilities, transportation, insurance, medical. All other expenses are lifestyle.)
2. Build up your savings. Interest rates on cash are really high right now and we are being paid to save money. I always recommend putting a minimum amount of money away each month even if you are trying to pay off debt. You should take a dual approach to get at least the equivalent of 3 months of expenses stashed away in savings.
3. Stick with your investment plan. A good investment plan should take into account periods of economic recession. Remember, your assets should be allocated based on your needs for income and growth over time.
4. Avoid “get-rich quick” investments or extreme commentaries. When volatility is high, it is natural to look for answers. Often, we see an up-tick in recommendations for extreme investment allocations. This could come in the form of a trend or opportunity that you don’t want to miss out on, or you may feel that you need to move all of your money into one asset class. Keep in mind that these extremes rarely pay off. It is always difficult to predict what asset class will perform the best, so diversification is extremely important. Here is what I recommend:
Our hierarchy of investing helps you maintain peace of mind be strategically determining how much capital you should allocate to needs vs. aspirations.
Don’t treat all of your money the same. Know how much risk you can take on to get an expected return. “Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you’re dealing with them in real time.”– Morgan Housel, The Psychology of Money
5. Evaluate your portfolio withdrawal rate. If you are approaching retirement or in retirement, it is crucial to understand how much of your portfolio you are withdrawing. A portfolio withdrawal rate that exceeds the long-term rate of inflation at 3.5% - 4% may mean that you are spending down principal which will affect the longevity of your financial freedom. Now is a good time to review your portfolio income. I recommend utilizing guaranteed income sources to cover your essential expenses. I also recommend making sure that your investment allocation is appropriate for your long-term growth needs. (We can help you evaluate this and make the appropriate adjustments!)
If you are saving for your future, make sure to evaluate the opportunity cost of withdrawing money from your investments or savings.
When the markets are down or the economy is sluggish and you withdraw money, it can be difficult to make that money back. Instead, it may be helpful to increase your investments while values are down.
Recently, I was reading the words of Bob Seawright in a book called, “How I Invest My Money” by Joshua Brown. Here is what he said: “One’s purposes provide the foundation upon which a financial plan is built. A good financial plan is designed to provide a means and the funding for living out one’s life…on purpose.”
I encourage you to evaluate your financial plan and your intentions to make sure that you have peace of mind. We are here to help!
Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.