In his most somber appraisal of the U.S. economy yet, Ben Bernanke, Chairman of the Federal Reserve, acknowledged on April 2 that we could be headed towards a recession. Bernanke admitted that the country’s gross national product is not likely to grow during the first half of 2008, and that it is “a very difficult period” for the economy.
“Recession is possible,” Bernanke told the Joint Economic Committee. “Our estimates are that we are slightly growing at the moment, but we think that there's a chance that for the first half as a whole, there might be a slight contraction.” When the nation’s economy slows down, it can be reflected in a number of ways, including a sagging stock market, higher unemployment rates and less overall consumption of goods and services. Technically, an economic downturn is only considered a recession when these conditions last for more than six months.
A recession is not something to freak out about. The economy is usually cyclical. “It’s the normal course of things, we’ve had six years of un-growth and businesses run in cycles,” says Christopher Brown, president of Ivy League Financial Advisors based in Rockville, Md. “You’re not going to have [the economy of] 1990 to1999 forever.” So what should you do to get ready? “Preparing for a recession is much like preparing for a heart attack,” says Charles Failla, a Certified Financial Planner and Principal with Sovereign Financial. “You don't want to wait until you feel chest pains to take action." Here is the best way to make sure your financial life is in order no matter what the next months bring to the economy:
Set up an emergency fund:
- “Evaluate how secure your job is and if there is a chance you might loose it, focus on how much is in your cash reserves or emergency fund,” says Brown. The general rule of thumb is to put away three to six months of your salary. Start looking at your expenses now so you can best estimate what it will take to create the right cushion.
- “You should never have a balance on your credit card,” says Failla. “If you are charging more than you can pay each month, then you're spending too much.” Carrying a balance on your mortgage is acceptable because the interest is tax deductible and it’s being paid towards something of great value, your house. Although mortgage debt is okay, be sure it's the right kind for your budget.
Shore up your portfolio:
- A recession will certainly put a strain on your stock portfolio, so this a good time to examine your asset allocation. “I don't recommend making drastic moves, like going 100% cash with the intent to buy back when the market goes down,” says Failla. “Instead, I would suggest making your stock holdings more defensive, like dividends paying ETFs [exchange traded mutual funds].” And make sure you’re properly diversified to defend against a hit to a specific sector. Have “a good balance of stocks, mutual funds and bonds,” says Brown. “And consider things like real estate investment trusts and commodities.” Work with a professional to make sure it’s done right.
Although these measures should already be part of your regular financial plan, if you haven’t addressed these items yet, the possibility of an impending recession is a good time to start working toward those goals.
And, if you’re going to make a big purchase in the next couple years, like financing your child’s college education or putting a down payment on a house, consider moving your funds to more conservative investments. “If you’re going to need the money and [do] not have time to recover from a market downturn,” says Brown, “it will keep that money more readily available.”
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