Recession Proof Your Finances

2020 brought us lots of stuff we didn’t need. I’m even tempted to celebrate New Year’s Eve for the first time in years just to bid it good riddance (cue the obligatory disclaimers about doing it while socially distanced, outside and probably by myself at this point given the Covid numbers). Chief amongst those unwanted things was having to stress test your financial situation during a surprising downturn that hit fast. Now that the world is clawing toward recovery, take some time to recession proof your finances before the next slowdown. This wealth management checklist is a good starting point. Here are five other things to focus on.

Maintain Emergency Reserves

We’ve all heard the advice to have a sufficient rainy day fund in case of emergency. This year, almost all of us faced that emergency simultaneously. Looking back, did you have enough money set aside to survive the rough patch?

A rainy day fund protects you from going into debt or selling long-term investments at a loss to cover emergency expenses. The Certified Financial Board of Standards recommends maintaining three to six months of living expenses in cash. Target a larger cushion if your income is volatile, if you have less job security, or if you have larger financial obligations.

That’s the theory. How did it hold up for you this year in practice? If the guidelines weren’t enough, or you weren’t following them yet, prioritize getting it right before the next recession. Track your spending and cut the easy things out to bolster your savings with one of these tools.

Lines of Credit

Beyond your rainy day fund, having lines of credit to tap into for emergencies is a great way to recession proof your finances. In Using Debt Smartly to Build Wealth, I recommended that individuals establish lines of credit in good times in case they’re needed in bad ones. One of the most common sources of credit lines available to individuals is a home equity line of credit (HELOC), which allows you to borrow against your home equity.

Most HELOC lenders lend up to 85 percent of your home equity. For example, if your home is worth $500,000 and you have a $250,000 mortgage on it, your equity is $250,000, and 85 percent of that is $212,500. Besides your home equity, the lender evaluates your credit score, work history, income, and current debt.

HELOC rates are variable, meaning that, as interest rates increase or decrease, the loan rate moves accordingly. Rates vary widely, so it’s important to shop around. Some lenders offer introductory rates. Check the fine print to see what those rates will adjust to after the honeymoon period.

If you have a line, but your home equity has increased given higher home prices, take the time to reapply for a new HELOC and increase your emergency borrowing power.

Investment Check-Up

How did your portfolio and investment strategy hold up during the first bear market in 11 years and fastest 35% stock market decline we’ve ever seen? These are important questions as you recession proof your finances.

For many investors, 2020 was the first time to live-test their risk tolerance and pieces of their investment strategy. It’s one thing to say on a questionnaire that you’ll buy stocks versus sell during a decline. It’s another to push the buy button and avoid the sell one when stuff happens.

Did you sell, hold, or buy?

If you sold:

  • Create a plan to get back into the market because once bull markets start, they tend to run for a while even amidst investor skepticism (R.I.P. 2009 – 2020 Bull Market & Lessons Learned).
  • If you have an advisor, work with them to reassess your risk tolerance and better position yourself the next time around.
  • Hire an advisor if you don’t have one. An advisor who kept you from selling this year would’ve saved you one or two decades of their fee.

If you wanted to buy, but the opportunity was too fleeting, or your portfolio is only set to rebalance at certain intervals (i.e., quarterly or annually), consider adopting a threshold rebalancing approach. In this case, that means determining a stock market decline level at which you automatically rebalance your portfolio into stocks.

Did you suffer permanent capital loss?

Stock market volatility is one thing, but as we’ve seen this year, investments rebound. That is unless they go to zero. If you owned speculative investments that did not make it, had a concentrated portfolio that hasn’t recovered, used complicated investment strategies that blew up, or had money you thought was invested safely in bonds that declined sharply, reassess!

Review Life and Disability Insurance

We don’t have to dwell on this and the next item (your estate plan). 2020 provided a sad reminder that having the right life and disability insurance coverage in place before you need it, or encounter a health issue that makes getting them harder, is important.

With life insurance, the biggest obstacle is typically procrastination. Sure, some question whether they need what’s recommended, but it’s mostly just getting around to it. Cross it off your list now and move on.

With disability, the biggest obstacle is skepticism about whether the cost is worth it. I tackled this in Disability Insurance Overview and Tips, which also provides some helpful coverage guidelines.

One final note: if your life and disability insurance is provided through your work benefits, consider getting private policies. You don’t want to lose your job and coverage at the same time!

Maintain an Updated Estate Plan

Estate plans protect your family’s finances from your incapacity and death. You can plan for the inability to handle your own affairs so the courts don’t determine who will make decisions for you. Estate plans also protect your family in the event of your untimely death and ensure that your wishes for your assets and other things are followed. Health care proxies with living will language, durable powers of attorney, wills, and trusts should be created and up-to-date. Some further thoughts on the how and why are available in You Need an Estate Plan.

Kill Your 5 Year Plan

For the business owners out there, enough with the five year plans as you recession proof your finances. This is exaggerated for effect, but whenever I hear about a five year plan to do something, I hear that there isn’t a plan. Five years is safe. It acknowledges the problem, but allows you to delay working on it.

Too many business owners talk about their five year plan to transition their business, retire, sell it, etc. They often pair it with wanting to get out before the next downturn. Well, the next downturn just hit and those five year plans are just as dusty and theoretical as they were before 2020. So, now what? Keeping your business alive and recovering your prior profitability and growth rate are your main priorities right now, but carve out time before too long to make those five year plans tangible. Does that mean you have to sell or transition your business in five years? Absolutely not. It means you need to pull that project from the far away file and start chipping away. There are tremendous resources out there to help you. Use them.

Final Thoughts

The COVID-19 recession and bear market were not predictable. That we will have another surprise downturn is certain. You can’t consistently time or predict these things. Take some time to review your finances and make sure you are prepared for the next one.

And my final piece of advice, if you knew all of this already, but haven’t been able to spend enough time implementing it, hire someone to help. All the knowledge in the world is meaningless if you can’t apply it to something as crucial as your financial well-being.