Recession Handbook for Small Investors
Ways to Protect Your Portfolio During Hard Times
In an uncertain economy or volatile stock market, fear and
recklessness are the biggest enemies of the disciplined long-term
investor. The former can cause otherwise good people not only cease
adding fresh savings to their complete portfolio, but in the worst
cases, to sell their partial ownership in businesses (shares of stock)
that will very likely be worth substantially more in ten years at
depressed prices. The latter can result in more money than one can
afford to lose being poured into equities because stocks are cheap so
the lure of leverage in the form of margin debt becomes too powerful
to overcome. The great tragedy in cases such as this is that the
investor might ultimately be proven correct, but lacks the net worth
to survive a margin call, getting wiped out in the process as he
watches others get rich off his ideas.
This article was put together to help small investors reduce their
risk during economic recessions; because each individual is obviously
different, you need to consult with a knowledgeable and respected
financial advisor or accountant to help you come up with a strategy
for your individual circumstances.
Otherwise, you know the drill: Go grab a cup of gourmet coffee, print
out a copy of this resource, curl up in a chair, and get started on
turning your personal balance sheet into a bastion of financial
strength for your family, enabling you to sleep well at night. If you
are looking for specific investment questions to consider during a
recession, read Managing Your Portfolio During a Recession for more
great ideas.
1. Build and maintain your liquidity at nearly all costs
I want you to think about the following statement. People dont go
bankrupt because of the total debt they owe; they go bankrupt because
they miss payments and the financial institutions then foreclose on or
take other measures against them. In the past, weve covered the topic
in several articles including A Lesson from September 11th - The
Importance of Liquidity and Liquid Assets and Why Building Equity at
the Expense of Liquidity Can Lead to Bankruptcy.
What does this mean? In simple terms, having a comfortable cash
cushion is very much like the safety net under the trapeze artists at
the circus. If something were to go wrong, such as you or your spouse
losing a job, business turning down, or your company reducing work
hours for staff, youd be able to draw upon those funds to keep the
electricity and water working, gasoline in the cars, and food in the
kids lunch boxes. It doesnt mean the experience will be stress-free,
but it could help ease those difficult times until you get back on
your feet.
It is absolutely vital that emergency funds be kept entirely in
historically safe, liquid areas such as savings and checking accounts
at well-capitalized, FDIC-insured banks, United States Treasury bills,
money market funds, or if you are the extremely paranoid type, stacks
of dollar bills parked in a safe deposit box. Do not comingle your
emergency fund with your regular bank or brokerage accounts because it
will be too tempting to spend or invest the money! The reason is
simple enough: The purpose of this money is not to grow. It is not to
make you rich. It is meant to be spent only if and when you are unable
to pay your bills through other means. It is the last resort fund.
2. Maintain sufficient health, life, disability, and other insurance
During hard times, it can be tempting to cut expenses in areas that
dont seem important. For many people, this includes insurance
coverage. In many, many cases this is a horrible mistake that can lead
to total financial destruction. Imagine, for insurance, if you were to
get rid of your health insurance with the intention of picking it up
later when times were better. What if you or your spouse had a heart
attack or were diagnosed with cancer? What if your children developed
a rare infection? Life events such as these rarely provide warning and
believing that you have the God-like power to predict them could cost
you your house, cars, and retirement. Dont be stupid.
Unless you are independently wealthy with piles of stocks, bonds,
mutual funds, businesses, real estate, et cetera, your most valuable
asset is probably your ability to work. Thats the reason disability
insurance is vital for most American families. Depending upon the
coverage chosen, a good policy can send you a paycheck if you are
unable to support yourself.
3. Cut Unnecessary Expenses And Pay Off Credit Cards!
Even if you dont feel any financial pressure, if you believe there is
a reasonable chance you might be hit by a recession, start cutting
unnecessary expenses, using the excess cash to start the process of
de-leveraging your balance sheet if possible upon the advice of a
qualified financial expert familiar with your situation. This will
lower your fixed payments each month, making your emergency fund go
further than it otherwise would have. Start with the obvious stuff the
$4 cups of cappuccino, the magazines at the newsstand, fast food, etc.
If you have credit card debt, pay it off immediately! Not only can you
not afford the sky-high interest rates that you are likely being
charged by your bank or financial institution, if things get really,
really bad, you might just need that backup source of liquidity your
credit lines afford you. If you are already maxed out, they wont be
there, making the problem worse.
On that same note, if you have margin balances at your brokerage firm
for any of your investment accounts, seriously consider paying them
off as soon as possible. When the economy gets rough, undisciplined
investors are often forced to sell their holdings, temporarily
depressing prices for those who were fortunate and wealthy enough to
hang on to their shares of stock. This means that if you have a margin
balance, its possible for your account equity to fall below the
maintenance requirement set by your financial institution or, in some
cases, the Federal Reserve. If that were to happen, youd need to come
up with money that very instant to avoid having them sell off your
assets at already-depressed prices, compounding your fiscal pain.
More Ways to Protect Your Portfolio During Hard Times
4. Expand the Pie
This is a theme weve hit on time and time again here at the site. The
easiest way to grow your net worth besides cutting expenses is to
generate more income from non-correlated sources. Imagine you are a
steel worker and your wife is a public school teacher. You could start
a small business from your home to generate just enough to pay the
mortgage each month, freeing you from total dependence on your jobs.
One couple that I heard from actually used side jobs from the Internet
to buy their cars.
In fact, this is a great way to expand your portfolio. When I was
younger, one of my favorite games was to set a goal. For instance, you
might say, Im going to buy fifty shares of Wells Fargo at $28.11 per
share, paid for entirely by side projects that dont come out of my
paycheck. To do that, you would have to make just over $1,400 after
tax and commissions.
You wouldnt believe how quickly those things add up, or how
intelligent you can become in terms of ways to ethically make the
money. If you could find a stock that grew 9% per annum with dividends
reinvested and did a project like this every year, youd add almost
$175,000 to your portfolio over thirty years. Its vital you begin
thinking like that.
5. Use the opportunity to buy depressed assets on the cheap
Recessions can be a marvelous opportunity to pick up cheap assets.
Youve got to be careful here because you dont want to appear as an
undertaking dancing during the plague, as one investor put it, but it
is a time that you can advance your own familys interests if you have
been disciplined and blessed enough to have available cash and a
strong balance sheet.
Find great quality companies that have talented management teams,
durable competitive advantages, high franchise value, strong financial
statements, good returns on capital, and the opportunity for future
growth (although if management is paying out earnings in the form of
share repurchase and cash dividends, the latter isnt necessary with a
low enough price-to-earnings ratio.)
This theme is also true if you own a business or firm of some kind.
When competitors are reeling, sometimes it pays to go on the
offensive, aggressively grabbing profitable business and consolidating
market share. When times recover, this could result in torrents of
cash piling into your office. John D. Rockefeller did just this thing
when he bought up nearly all of the rival refiners in Cleveland during
a time of crashing crude prices, putting him on trajectory to building
one of the greatest fortunes the world has ever known.
