A recession will happen again.
Almost two years ago economists began to worry about a potential downturn. Last December, these warnings took on a particularly sharp tone when the bond market experienced what's known as a partial "inverted yield curve." This means that investors began wanting long term bonds more than short term ones, because short-term bonds were paying more interest.
This typically means that investors expect the market to take a downturn. They want their money out of stocks and other vulnerable assets and will pay for that protection. Historically an inverted yield curve has been one of the most reliable signals of an imminent recession. The good news is that at time of writing the yield curve has returned to normal. So maybe this was just a short term panic.
That doesn't mean a recession won't happen, though. The economy moves in cycles and, yield curve or no, it's been more than 10 years since the last one ended.
What should you do about that?
What Happens in a Recession?
First thing is to understand what a recession is and what it does.
A recession is a market downturn generally measured by a decline in both GDP and the stock market. There's no formal definition of when the economy has entered a recession. While some people use the rule of thumb that a recession means two straight quarters of negative GDP growth, the Federal Reserve and the NBER prefer a more holistic model. One document from the St. Louis Federal Reserve defines a recession as a "significant decline in economic activity spreading across the economy, lasting more than a few months" taking into account "payroll employment and several measures of domestic production and income."
Unfortunately, a recession is generally only recognized when the economy is mired in one. As a result, it's often difficult for policymakers to effectively respond in time to prevent the worst of the suffering.
For most people, recessions are characterized by two main issues: loss of employment and loss of savings. The stock market typically falls, causing many people to lose significant value from their investments. For the average American, this most likely means losses to their retirement accounts. At the same time, companies begin laying workers off and unemployment soars as large numbers of newly-unemployed workers compete for scarce opportunities.
All of this typically leads individual consumers to spend less, as they either worry about unemployment or have lost their jobs. This creates what's known as a negative feedback loop. People are worried about unemployment, so they spend less. As consumers spend less, businesses have fewer customers and continue laying workers off.
So what should you do to prepare for this?
How to Prepare for a Recession
First things first, look to your emergency fund.
In the current economy unemployment lasts longer than it used to. According to BLS statistics 36% of job seekers report needing more than 15 weeks to find a new job, and that number will only go up in a downturn. In fact, during the Great Recession, many people remained out of work for over a year before finding a new position.
While you can't save for a full year's worth of expenses, aim for having at least six months' worth in the bank. This means enough money to cover all your basic necessities: housing, food, bills, non-negotiable debt and the like. Don't invest it or lock it up in a fund. This is money you want to keep absolutely safe and completely liquid, because it's your safety net if things go south.
We know that's a lot of money, but during the current, tight job market the average length of unemployment is 22 weeks. That won't get any better if employers start laying people off.
Work On Job Skills and Networking
Start a Job Hunt
The absolute worst time to start applying for a job is when you need one. It's perverse, but it's the reality of our hiring systems. Employers are like fickle dates… the more unavailable you are, the more they want you.
This means that the time to start preparing your recession employment plan is right now. Your big risk during a downturn is getting laid off and having to compete in a market filled with other newly-unemployed workers. We're not saying quit your job to beat the rush. We're saying start planning early.
Boost Your Skills
What will make you a more competitive candidate in your field? What skills and certifications could you add; what additional tasks could you take on? Does your profession have forms of pro-bono work you could do or associations you could join to raise your profile?
Too, what is the state of your professional network? These are the contacts you'll rely on if it comes time to look for new work, so begin renewing all those acquaintances now. Start going to events in your area, or ask a former colleague out for drinks just to renew ties. Update your resume and look for any holes.
In particular, take a look at your references. Many people who have worked steadily for years will find that this list has dwindled. If you've had the same employer for the last five years, you might have only one or two current references you can call on while the rest are long stale. Do what you can to create new contacts at work so you have new voices to call on if the time comes.
Don't Change Much About Your Portfolio
Now, look at your financial portfolio.
For most investors your response to a recession should be… well, we don't want to say it's not a big deal, but it shouldn't change much.
As we've written elsewhere, the best approach for retail investors is to build their portfolio around the long term. There's nothing wrong with setting aside a percent of your assets for speculation, but most of your portfolio should be selected for its long-term potential. You should buy securities that you think will grow steadily over a period of years based on the asset's underlying fundamentals. In many cases, your best bet will be a straight and simple market index fund that lets you reap the rewards of the stock market.
Meanwhile, the average recession lasts about 11 months.
If you've built a portfolio that will grow for several years there is absolutely no reason to change that plan around a disruption that will last for just one. Most of your investments will have plenty of time to recover their value once the recession has ended.
We're not saying don't look at your investment strategy at all. If you think you have some assets that might not recover from a recession, perhaps sell those. Or if you have speculative assets that you'd like to profit off of soon, move those around too. But by and large a recession shouldn't change much about your investing strategy.
Protect Money You'll Need Soon
Except for money you'll need in the near future.
It's a back-of-napkin figure, but research suggests that it takes the economy about two and a half months to recover from a recession for each year of the economic growth that preceded it. So, given that the last recession ended in 2009, if a recession begins in 2020 expect it to last a year and take another 25 months before the economy is back to where it is today.
That's absolutely not a hard and fast rule, but it gives us some general guidance. If you think a recession might be coming (and we emphasize that economists do not agree that one necessarily is), move to protect any money you'll need within the next three years or so.
This means, for example, anyone who plans on retiring between now and 2023. Or parents with college funds that they'll need in the next three years. If you have a portfolio with a deadline coming up, by now you should have begun switching it to more conservative assets anyway. It might be wise to accelerate that process. Otherwise, you might not have time to recover any losses before you need this money.
Prepare to Invest
One of the biggest mistakes people make during a recession is that they disrupt their investment plan. Worse, many people start to sell. This is a terrible idea.
What you should start planning to do is buy.
If you can afford to do so, begin setting aside money for future investments. During a recession stock prices take a hit, often taking them well below their true value. This is an ideal opportunity to invest. In fact, if you have money in any speculative assets, pre-recession is the right time to convert it all to cash.
As much as practical, have money on hand to invest when the market goes south. You want to buy when prices are low so you can profit when they return to growth.
It's never too late - or too early - to plan and invest for the retirement you deserve. Get more information and a free trial subscription toTheStreet's Retirement Dailyto learn more about saving for and living in retirement. Got questions about money, retirement and/or investments? EmailRobert.Powell@TheStreet.com.