If this is the first time you have experienced a severe downturn, while you are invested in the stock market, recession 2020 is bound to feel crazy. Something that did not even seem like a remote possibility only a few weeks ago has now taken over our lives. It feels like we’re living through a sci-fi movie. The phrase, reality is stranger than fiction, has never rung truer.
However, if you can pull yourself out of the current scenario and look at it in a historical context, this downturn is actually unremarkable. Since World War II, the US has been through 11 recessions. Each recession was caused by something unprecedented and unforeseen and each time, the market fully recovered to reach new highs.
So as apocalyptic as it may seem, know that we have been through apocalypses and come out stronger 11 times before. In fact, recessions and booms are a normal part of a free market economy like that of the US.
Federal Reserve has acted swiftly
What is also reassuring about this recession is that the Federal Reserve (Fed) seems to have learned many hard lessons from the last recession, the financial crisis of 2008. The Fed is the central bank of the US. Together with the Treasury Department, it creates monetary policies that control the supply of US dollars. The Fed has taken quick steps to prevent this recession from turning into another financial crisis. It has done this by passing policies such as providing emergency cash for businesses and financial institutions.
According to a famous paper published by economists, Carmen Reinhart and Ken Rogoff, recessions that involve a financial crisis take much longer to recover from. They also leave a lasting impact on everything from stock prices and home prices to unemployment and government debt. So, this swift action by the Fed has preempted such a banking crisis that leads to a deep recession.
While the Great Recession of 2008 lasted 18 months, depending on the length of the shutdown, this recession may be shorter.
Corporate bailout has been fairer
On the fiscal policy side, Congress has also learned lessons from the financial crisis. Fiscal policies involve programs designed to stimulate the economy by the government spending money. An example is the $2 trillion stimulus package that is set to pass this week. While the government being saddled with another humungous debt is concerning for the long term, the good thing about this stimulus is that it’s focused towards benefiting individuals directly rather than benefiting certain corporations. The widely criticized bank bailout from 2008 did save the economy from a financial crisis but it resulted in major cash injections into banks that had caused the financial crisis in the first place. This happened while households and homeowners suffered with little help.
The bank bailout recipients were also free to pay bonuses, often to the same people who had caused the crisis. Additionally, once the bailout ended, the banks could benefit themselves and their shareholders by raising dividends and buying back their shares.
This time around, the bailout is directed towards saving households and small businesses. It includes $250 billion in increased unemployment insurance and $300 billion in direct payments to households, as well as $250 billion in forgivable loans to small businesses. It does include $500 billion in loans to big corporations such as the airline industry but with strings attached. The conditions include eliminating share buybacks and dividends over the life of the loan and limiting bonuses.
Given that a stable economy with strong households is generally good for stocks, these policies although not without risks are reassuring for the stock market.
So, given this backdrop, what money moves should you be making right now?
1.Strengthen your emergency fund
You may have heard before that you need to have 3-6 months of cash in hand for unavoidable expenses like grocery, health insurance, etc. This has never been more important than now as many are losing their jobs. Depending on how stable your income source is and how easy it will be for you to find another job, you may need to save for even more months. This is a decision only you can make. So, look at your expenses, determine the ones you can’t live without and should you need more cash, direct any new income towards your emergency fund.
2. Consider if it is time to buy stocks
Many people are wondering if this is a good time to invest. While it is very difficult, if not impossible to time the market, if you have excess cash today, this is a good time. However, you should invest in stocks only if you have a long time horizon, that is if you don’t need the cash soon because none of us know how long the downturn will truly last and if it will get worse. So, before you decide to invest, make sure you’re investing for the long-term and you have sufficient cash in your emergency fund.
If you have a stable income and an emergency fund set, then continue to contribute to your 401K and invest your savings.
3. Examine your asset allocation
If you started investing a few years or months ago, then until recently, you had only experienced a bull market. As a result, you may not have fully comprehended the risks of investing in stocks. Now that you have experienced a bear market, re-examine your goals, your liquidity needs and your risk tolerance. Do so by taking into account the full cycle of a bull and bear market. If it is different than you originally thought, you may need to change your asset allocation.
For example, if you find that you actually need to draw cash from your portfolio even when the markets are down, you may need to make your portfolio less risky and increase your allocation to bonds. If this is true for you, the next question is when should you make the change. You may want to wait to sell stocks now to avoid selling at the bottom. Alternatively, you could direct any new dividends into buying bonds instead of reinvesting them to buy new shares. This way you gradually shift your asset allocation.
4. Rebalance your portfolio
As some assets in your portfolio appreciate and some lose value, you should be selling the ones that appreciate and buying the ones that lose value. This way, you buy low and sell high and keep your asset allocation intact. With the recent downturn, stocks in your portfolio have lost value compared to high-quality bonds. Similarly, small-cap stocks have lost more value than large-cap stocks. So, you should use this opportunity to sell the winners and buy the losers. This way you buy stocks at a lower price. If you have a financial advisor, they should be doing this for you.
5. Refinance your mortgage
With the Fed lowering interest rates to zero, you can now get a really low mortgage rate. So, talk to a mortgage lender about refinancing your mortgage. Make sure you take all costs into account before making a decision to refinance.
6. File unemployment benefits
If you have been laid off, file for unemployment immediately. A record 3.28 million workers applied for unemployment benefits last week. So, the process might take longer than usual. But, with the new stimulus package, Congress has pledged an additional $600 for 4 months in unemployment benefits. It has also expanded benefits to include gig workers and freelancers. So, this will help you while you’re looking for another job.