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Months of volatile stock markets, soaring inflation and rising interest rates have left many investors wondering if a recession is on the way.
The stock market fell again on Thursday, with the S&P 500 capping its worst six-month start to the year since 1970. In total, it’s down more than 20% since the start of the year. The Dow Jones Industrial Average and the Nasdaq Composite are also down significantly since the start of 2022, dropping more than 15% and almost 30% respectively.
Meanwhile, consumer sentiment toward the economy has plummeted, according to the University of Michigan Consumer Close Survey, measuring a 14.4% drop in June and a record low for The report.
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Some 68% of CFOs expect a recession to occur in the first half of 2023, according to CNBC’s CFO survey. However, expert forecasts vary as to the possibility of an economic slowdown.
“We all understand that markets go through cycles and recession is 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, Herman urges clients to be proactive and ensure their wallets are ready.
Diversify your portfolio
Diversification is key when preparing for a possible economic downturn, said Anthony Watson, CFP and founder and president of Thrive Retirement Specialists in Dearborn, Michigan.
You can reduce company-specific risk by opting for funds rather than individual stocks, as you are less likely to feel that a company is going bankrupt within an exchange-traded fund of 4,000 others, a- he declared.
He suggests checking your mix of growth stocks, which should typically provide above-average returns, and value stocks, which typically trade below the value of the asset.
“Value stocks tend to outperform growth stocks as they enter recessions,” Watson explained.
International exposure is also important, and many investors look to 100% domestic assets for equity allocations, he added. As the US Federal Reserve aggressively fights inflation, the strategies of other central banks could trigger other growth trajectories.
Revisiting bond allocations
Since market interest rates and bond prices generally move in opposite directions, the Fed’s rate hikes caused bond values to fall. The benchmark 10-year Treasury note, which rises when bond prices fall, rose above 3.48% on June 14, the highest yield in 11 years.
Despite falling prices, bonds are still a key part of your portfolio, Watson said. If stocks crash before a recession, interest rates may also fall, allowing bond prices to recover, which may offset stock losses.
“Over time, this negative correlation tends to show up,” he said. “It’s not necessarily day-to-day.”
Advisors also consider duration, which measures a bond’s sensitivity to changes in interest rates based on coupon, time to maturity and yield paid over the entire term. Generally, the longer the duration of a bond, the more likely it is to be affected by rising interest rates.
“Higher-yielding bonds with shorter maturities are now attractive, and we have kept our fixed-income holdings in this area,” added Herman of PRW Wealth Management.
Assess cash reserves
In an environment of high inflation and low returns on savings accounts, it has become less attractive to hold cash. However, retirees still need a cash reserve to avoid what is known as ‘sequence of returns’ risk.
You need to be careful when selling assets and making withdrawals, as this can hurt your portfolio in the long run. “That’s how you fall prey to the negative streak of returns, which will eat away at your retirement,” Watson said at Thrive Retirement Specialists.
However, retirees can avoid dipping into their nest egg during times of big losses with a large cash reserve and access to a home equity line of credit, he added.
Of course, the exact amount needed may depend on 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 business cycles. But there is no guarantee that a future slowdown will not be longer.
Cash reserves are also important for investors in the “accumulation phase,” with a longer time to retirement, said Catherine Valega, CFP and wealth consultant at Green Bee Advisory in Winchester, Massachusetts.
“People really need to make sure they have enough emergency savings,” she said, suggesting 12 to 24 months of savings spending to prepare for possible layoffs.
“I tend to be more conservative than many,” she said, noting the more widely touted suggestion of three to six months of spending. “I don’t think that’s enough.”
With added savings, you have more time to strategize for your next career move after a job loss, rather than feeling the pressure to take your first job offer to cover the bills.
“If you have enough liquid emergency savings, you have more options,” she said.
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