It’s unofficially official: we’re in an economic recession for the second time in two years. At least, that’s according to government data published this week.
This news comes from the Bureau of Economic Analysis’ latest report on economic activity, which showed that U.S. Gross Domestic Product, or GDP growth, contracted during April, May, and June, marking the second straight quarterly decline so far this year.
And by some measures, two consecutive contractions in GDP is considered the start of a recession.
What is a Recession?
So, with all of this talk about a recession, some of you may be asking, “what exactly is a recession?” Well, as of late, there’s little consensus as to the definition of a recession. In fact, the White House has been working hard this week to redefine what it means to be in a recession. Nevertheless, a recession can be defined as simply a decline in economic activity over some time.
And it’s important to keep in mind that recessions are not caused by a single event, but instead occur as a result of many factors, including rising interest rates, higher inflation, declining consumer spending and investment, falling production capacity and rising unemployment.
Now, our country has been through 48 recessions since its founding. And since 1947, when government statistics were gathered more consistently, data show that we’ve been through about twelve recessions in the past 75 years.
Of those twelve recessions, ten of them have occurred when two quarterly GDP declines were in place. So, from this perspective, if we use history as our guide, we could safely say that a two-quarter decline in GDP growth is consistent with a recession.
So, Are We in a Recession?
Now, it’s important to note that while we’ve experienced two consecutive declines in economic growth, the official measure of a recession is often broader than looking at GDP alone.
To be sure, the National Bureau of Economic Research, or NBER, considers several indicators before officially calling a recession. They look at what’s going on in the labor market, consumer spending, industrial production, and other measures before calling slowing growth a recession.
While some of these indicators have softened recently, they’re generally in what appears to be still positive territory. With that said, if we look back to the Great Recession, we find that while the NBER called the recession starting in December 2007, industrial production didn’t roll over until April of the following year.
We can even go back to the recession of 2001 around the Dot Com bust to find that there’s no singular measure of a recession. For example, while the NBER called a recession starting in March 2001, GDP did not even go through a two-quarter contraction during this period. Nevertheless, U.S. economic activity did experience a decline broad enough to have been considered a recession.
With all that said, the NBER does not have a track record of calling recessions in real-time, and often they confirm their findings only months after a recession has already begun or ended.
So, are we in a recession? Well, the short answer to this question is likely yes.
While the NBER hasn’t officially come out and called a recession yet, there’s a solid reason to believe that we may be in one today. Again, over the past 75 years, there’s been a couple periods where the economy experienced a two-quarter decline, and a recession did not occur, and that was in 1947.
Since then, every recession has been accompanied by a two-quarter decline in GDP like we’ve experienced so far this year.
How Does a Recession Affect Me?
Now, given all the headlines surrounding recessions, you might wonder how today’s current events affect you.
Well, how a recession might affect you depends on your situation and where you’re at in your financial independence journey.
If you are in the accumulation phase, saving money and preparing for your definition of financial freedom, you may have some obstacles to navigate in the months ahead. For instance, layoffs tend to rise during economic downturns, so having an emergency cash reserve on hand to deal with a potential unemployment situation will be essential to navigating this period of economic uncertainty.
With that said, if your emergency savings are topped up, and you’re feeling confident about your current job prospects, then a recession might provide you with an opportunity to buy financial assets at a discount or invest in distressed real estate or other business ventures as the economy weakness.
Now, you’ll likely find yourself with a unique set of challenges if you’re an individual in the distribution phase of your financial independence journey. For example, market pullbacks or bear markets often accompany recessions.
And by many measures, we’re already in a bear market today.
So, if you’re currently dependent on your investment savings to cover living expenses during retirement, then taking distributions from your portfolio when prices are down could mean locking in market losses at an inopportune time.
If you’ve been following along with our commentary over the past few months, however, then you’ll likely know how imperative it is to have an adequate cash reserve to cover 12–18 months of living expenses during this time.
This cash buffer can allow you to maintain your standard of living even during a recession-induced bear market, while giving your portfolio enough time to recover once the economic outlook clears up.
While recessions can be devastating to individuals, businesses, and the economy at large, they are not always a bad thing: when the economy contracts it means financial resources are being allocated more efficiently. And this can help to correct imbalances within the system, especially after an extended period of loose monetary and fiscal policies and free-wheeling market conditions.
Fortunately for most people, it’s possible to weather even severe economic downturns as long as you’re prepared financially and emotionally.
Preparing for a Recession: Start with Your Plan
So how should you position your finances for weaker economic growth and heightened market volatility in the months ahead? Well, if you’re an individual focused on mastering your financial independence journey, the short answer is to stay committed to executing on your long-term financial plan.
During times of economic and market uncertainty, for some of us, there’s a tendency for our vision to narrow to the present, tempting us to change the way we handle our finances or investment allocations as a way to mitigate what appears to be an immediate financial threat.
Even so, if you have a well-structured financial plan and a disciplined investment process already in place, then the action that you’ll likely need to focus on today is consistently doing the work necessary to execute your plan.
To be sure, if you have a well-crafted financial plan already in place, then those actions should be defined in your implementation schedule. Otherwise, developing a set of strategies to align your financial resources with your long-term goals should be a priority if you don’t already have a comprehensive financial plan in place.
Certainly, a solid financial plan lays out how to connect the dots between your financial resources and ideal long-term lifestyle goals. At the same time, it identifies predefined strategies and tactics that you can tap into to manage adverse conditions when they inevitably arise in the near term.
Have Adequate Cash on Hand
Once your financial plan is in place, the next thing you’ll likely need to focus on is getting back to the basics.
What do we mean by getting back to the basics? Well, what we mean here is ensuring that you have enough cash on hand to weather the impending economic storm, whether you’re dependent on a job or a retirement nest egg to cover your household income needs.
When it comes to managing your portfolio during a recession, there’s no substitute for cash. Sometimes it can be hard to get excited about cash, but in a recession, having some money in reserve can save your investments and keep their value whole while waiting out the downturn.
Cash is also necessary because it’s a great way to rebalance your portfolio back toward its original goals if something causes some of your investments to perform poorly (which often is inevitable!).
Having cash on hand to be able to buy more shares of one security or another when prices decline may enable you to take advantage of opportunities and spread risk across various asset classes. This is one reason why we advocate for maintaining investment exposure across stocks, bonds, and real estate in both U.S. and international markets.
Assess Your Current Portfolio
The next step for investing during a recession is to get a good picture of your current portfolio. What’s in it? How much risk are you taking? What are your investment goals, and how much risk can you stomach?
Now that you have a good understanding of where you stand, think about how to protect yourself during an economic downturn.
Don’t Panic and Don’t Sell Everything
One essential way to safeguard your investment portfolio is to protect it from yourself. While headlines will focus on the negatives that recessions often bring, you’ll likely need to remember that this is not the end of the world — it is just a temporary setback.
You likely already went through this back in 2020 and made it through in one piece.
Certainly, no one can predict what will happen next, but if you sell everything now, you may be selling at a loss and will regret it later.
Another Recession is Here. Now what?
When it comes down to it, various indicators suggest that we’re likely already in a recession. And this time around, the government likely won’t be ready to cut checks and support the economy as it had in the past.
That’s why if you’re serious about mastering your journey to financial independence, then now’s the time to ensure that you have a solid financial plan in place, that your investment strategy is aligned with your long-term plan and that you’re effectively executing on your implementation schedule.
If you are afraid of losing money in your investments, don’t panic and sell everything; instead, get some professional advice from someone who knows what they’re doing.
Most investors get through downturns just fine if they have a little patience and a good strategy.
Many investors who lost money during the Great Recession or during the Pandemic did so because they didn’t have a diversified portfolio or got out of the markets altogether.
And there’s no such thing as a perfect investment strategy. But if you have a plan and stick to it, you’ll be in better shape than most.
If you’ve been through a recession before, you know how difficult it can be. But if you have a solid strategy and stick to it, it doesn’t have to be all that stressful. The key is to have enough cash on hand to navigate market and economic uncertainty.
And again, stay calm and don’t panic sell your investments just because there’s bad news out there! Remember: recessions come and go. But over time, they can provide tremendous buying opportunities and allow the value of a diversified portfolio tends to go up in value over the long-term if bought at reasonable prices.