The Upside of a Downturn
The toxic combination of a four-decade high inflation and the Federal Reserve’s aggressive interest rate hike campaign has increased the odds of a recession within the next year. The warnings are coming from lots of different voices: Treasury Secretary Janet Yellen (“I expect the economy to slow”), Federal Reserve Chairman Jerome Powell (while it is not the “intended outcome”, the central bank’s inflation-fighting campaign could make a recession “a possibility”), Goldman Sachs (“We now see recession risk as higher and more front-loaded”), and Elon Musk, who has “a super bad feeling" about the economy.
Even if the NBER Business Cycle Dating Committee does not officially make the recession call, it is becoming obvious that a slowdown from last year’s zippy growth of 5.5 percent (the fastest GDP since 1984) has begun. If we do see a recession, it’s hard to know how bad it will be or how long it might last. For example, the COVID downturn lasted just a few months, but job losses were steep, with unemployment peaking at 14.7 percent. Conversely, the Great Recession started in December 2007 and lasted until June 2010, and unemployment topped out at 10 percent.
Adding to the confusion is the unique nature of the pandemic, which created an extra layer of emotions to the economic outlook. After being cooped up for the better part of two years, Americans have been willing to spend briskly, despite higher prices. Still, most economists predict as people spend down their excess pandemic savings and incomes adjusted for inflation turn negative, consumers will be forced to tighten their purse strings and economic activity will peter out.
Instead of feeling helpless, now is a good time to highlight six potential upsides of a downturn in both the economy and in financial markets.
Emergency Reserve funds are cool again. It’s hard to believe that only two years ago we learned this lesson, only to allow a post-pandemic spending surge to take over the rational side of our brains. In just six months, with recession fears swirling, people are waking up not only to higher prices, but also to the idea that a self-funded safety net can be the difference between tossing and turning and getting a good night’s sleep.
While the economy is still growing, make sure that your emergency reserve fund can cover 6-12 months of living expenses. If you are already retired, consider making that 1-2 years’ worth of expenses, to avoid being forced to sell assets at lower levels just to pay the bills. Keep this money in an accessible savings, checking, or money market account. It should be a little easier to make the leap into safe stuff now that the Federal Reserve has increased short-term interest rates from zero.
Reducing credit card (or any high interest) debt may be the best investment of 2022. The idea of paying down a 15-20 percent credit card balance is even more compelling when financial markets are in disarray. Instead of being lured into thinking that they will make more by investing than paying down debt, most consumers and would-be investors can now see that the guaranteed (and risk free) return that debt pay down delivers is not just good for your balance sheet, it will likely end up being the best investment of the year.
Dollar cost averaging makes you bold. It’s tough to be brave about investing when you see a market index collapse. That’s why putting a set amount of money into a portfolio, like you do when you contribute to an employer-based retirement plan, can help you continue socking away your hard-earned dollars, even when you would really prefer to stash your cash under the proverbial mattress.
Roth conversions are more compelling. If you have a traditional (pre-tax) retirement account, market losses may make a conversion into a Roth a little less burdensome. While you will still have to pay taxes on the amount converted, the amount due could be smaller. As an example, if the account was worth $10,000 at the beginning of the year and is now worth $7,500, a conversion today would add the lower mount to your taxable income. Ideally, whatever you convert keeps you in a reasonable tax bracket and for this to work, you need to have non-retirement funds available to pay the tax due. Once you convert to a Roth, assets grow tax-free and when you retire and withdraw the money, there will be no tax due. Because Roth plans are not subject to Required Minimum Distributions (RMDs), many use them to help control future taxation of Social Security benefits and/or increased costs of Medicare, which are income tested.
Your job may be a ballast against uncertainty. The current labor market remains strong, despite reports of some tech companies pulling back on hiring plans. In fact, there are still more than 11 million job openings and in many industries, bosses are making concessions to keep existing workers happy. That said, if a slowdown is coming, consider upskilling yourself, either through free platforms or maybe see if your company will foot the bill for a certificate program. Don’t forget to spend time on your network so that it can be activated if your situation changes.
That side hustle could come in handy. During the pandemic, many workers found time to create another stream of income, on the side. These side hustles became a way to make a little bit of money, while also being a way to channel creative energy. Many who idled these projects should consider firing up the side hustle to bring in extra income and to exert some control over their financial lives.