Some experts say a recession is coming. How do you prepare your wallet?

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Months of stock market volatility, rising inflation and rising interest rates have left many investors wondering if a recession is about to happen.

The stock market fell again on Thursday, with the S&P 500 off its worst start in six months since 1970. Overall, it’s down more than 20% year-to-date. The Dow Jones Industrial Average and Nasdaq Composite have also fallen significantly since the start of 2022, dropping more than 15% and nearly 30%, respectively.

Meanwhile, consumer sentiment about the economy waned, according to a closely watched University of Michigan consumer survey, which measured a 14.4% drop in June and a record low for a report.

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About 68% of CFOs expect a recession during the first half of 2023, according to a CFO survey on CNBC. However, experts’ expectations differ about the possibility of an economic downturn.

“We all understand that markets go through cycles and that recessions are part of the cycle we may face,” said certified financial planner Elliot Herman, partner at PRW Wealth Management in Quincy, Massachusetts.

However, since no one can predict if and when a downturn will occur, Hermann pushes clients to be proactive and make sure their portfolio is ready.

Diversify your portfolio

Anthony Watson, a CFP and founder and president of Thrive Retirement Specialists in Dearborn, Michigan, said diversification is critical when preparing for a potential economic recession.

He said that you can reduce your company’s risk by choosing money rather than individual stocks because you won’t likely feel like a company going bankrupt within an exchange-traded fund of 4,000 other companies.

Value stocks tend to outperform growth stocks that have entered a recession.

Anthony Watson

Founder and President of Thrive Retirement Specialists

He suggests checking the mix of developing stocks, which are generally expected to provide above-average returns, and value stocks, usually trading below the value of the asset.

“Value stocks tend to outperform growth stocks that are entering a recession,” Watson explained.

He added that international exposure is also important, and many investors are lagging 100% of domestic assets for stock allotment. While the US Federal Reserve is aggressively fighting inflation, the strategies of other central banks may lead to other growth paths.

Reconsideration of bond allocations

Because market interest rates and bond prices typically move in opposite directions, Fed increases have dumped bond values. The benchmark 10-year Treasury, which rises when bond prices fall, topped 3.48% on June 14, the highest yield in 11 years.

Watson said that despite the decline in prices, bonds are still an essential part of your portfolio. If stocks fall heading for a recession, interest rates may fall as well, allowing bond prices to recover, which can offset stock losses.

“Over time, this negative association tends to manifest itself,” he said. “It doesn’t have to be day in and day out.”

Advisors also consider term, which measures a bond’s sensitivity to interest rate changes based on the coupon, time to maturity, and the return paid over the term. In general, the longer a bond is, the more likely it will be affected by higher interest rates.

“High-yield bonds with shorter maturities are now attractive, and we’ve maintained our steady income in this area,” added Hermann of PRW Wealth Management.

Cash Reserve Assessment

Amid rising inflation and lower savings account returns, holding cash has become less attractive. However, retirees still need a cash store to avoid what is known as “return cascade” risk.

You should pay attention to when to sell assets and make withdrawals, as this can cause long-term damage to your portfolio. “This is how you fall prey to the negative sequence of returns, which will eat your retirement alive,” said Watson of Thrive Retirement Specialists.

However, retirees may avoid tapping into their nest during periods of heavy losses with a large cash reserve and access to a line of credit for home purchases, he said.

Of course, the exact amount required may depend on your monthly expenses and other sources of income, such as Social Security or a pension.

From 1945 to 2009, the average recession lasted 11 months, according to the National Bureau of Economic Research, the official documenter of economic cycles. But there is no guarantee that the downturn in the future will not be prolonged.

Cash reserves are also important for investors in the “accumulation phase,” with a longer timeline before retirement, said Catherine Valleja, a CFP and wealth advisor at Green Bee Advisory in Winchester, Massachusetts.

I tend to be more conservative than many because I’ve seen three to six months in emergency expenses, and I don’t think that’s enough.

Catherine Vallega

Wealth Advisor at Green Bee Advisory

“People really need to make sure they have enough emergency savings,” she said, suggesting 12 to 24 months of spending in savings to prepare for potential layoffs.

“I tend to be more conservative than many,” she said, referring to the more prevalent suggestion of spending three to six months. “I don’t think that’s enough.”

With the extra savings, there’s more time to strategize for your next career move after a job loss, rather than feeling pressured to accept your first job offer to cover the bills.

“If you have enough liquid emergency savings, you give yourself more options,” she said.

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