How to Limit Downside while Increasing Upside during a Recession

It is here. I initially wrote about the 2020 recession on August 24, 2019. Although the technical definition for a recession is loosely defined as a significant decline in general economic activity in a designated region. It has been typically recognized as two consecutive quarters of economic decline, as reflected by GDP in conjunction with monthly indicators like a rise in unemployment. The employment report released on April 3rd shows an unemployment rate of 4.4 percent (an increase of nearly a percentage point), and 700,000 jobs lost in the month. While it is a downbeat reading of the labor market, it understates the situation dramatically. This report describes the labor market based on the reference week ending March 14th, before the bulk of the social distancing policies were in place and when new unemployment insurance claims were just 280,000. The next GDP report on April 29th will be for the first quarter, when at least 10 of the 13 weeks were largely normal. Yet the scale of jobs lost and economic activity paused have already made clear that we are facing a shocking economic downturn. The cessation of economic activity due to the public health response to the COVID-19 pandemic has brought on the most rapid economic breakdown in U.S. history. In the week ending March 21st, there were over 3 million new unemployment insurance claims filed, more than four times the weekly record. It took five weeks at the height of the Great Recession to add a comparable number to the unemployment rolls. In the week ending March 28th, over 6 million new claims were filed, 10 times as many as in the worst week prior to this year. Forecasters have suggested U.S. economic output will contract at an annualized rate of 20–30 percent in the second quarter of 2020—a reduction in activity three times worse than the worst quarter of 2008—and international bodies are now forecasting a global recession this year.
Unlike in the Great Depression, the Federal Reserve has responded aggressively—keeping financial markets functioning and avoiding sharp reductions in liquidity or credit. Furthermore, the financial system has better buffers and resiliency than at the start of the Great Recession following the reforms passed over the last decade, including the Dodd-Frank financial reform. In addition, Congress has shown considerable urgency, passing three packages that total well over 2 trillion dollars to fund the health system, support households, and provide loans and grants to firms to keep them alive during the slump. While a great deal of policy activity has already been launched, the scale of the human and economic damage makes clear that policymakers must continue to work. The shocking numbers of newly unemployed workers means that millions of people will need to find new jobs or reattach to their prior firms. This can be a time-consuming and difficult process. The millions of businesses that have had to shutter have options to survive based on lending and grants from the government, but navigating longer-term risks and the new programs may be a challenge for many.
Regarding duration, though, this recession still could end up on the short side. In fact, there is reason to believe it’ll be much shorter than the 2007-09 Great Recession, which dragged on for 18 months. Here is why we believe that this recession will be extremely deep, very broad, but relatively brief. By mid-year, we’ll have seen a huge plunge in economic activity forced by medically-mandated shutdowns and widespread job losses cascading through the economy. But if those shutdowns start ebbing by summertime, the economy will then begin reviving, albeit slowly and partially. As a result, the level of economic activity – in terms of output, employment, income and sales – will necessarily rise above the lows seen during the worst of the closures. By definition, when such economic activity starts to increase on a sustained basis – even slowly from a low base – the recession will have ended. So it is plausible that this recession could last about a half-year, rather than the one and a half years we endured during the Great Recession.
However, there are steps we can take to limit the downside while still maintaining the potential for tremendous upside when the market rebounds.
  1. Hold some Cash – As they say, what goes down must come up. Warren Buffet once said, “Be fearful when others are greedy and greedy when others are fearful.” The current market conditions provides a great window for future gains. In order to take advantage of the market, we need to have substantial access to cash that can be deployed as needed.
2. Dollar-cost average into Equities – It is truly believed that timing the market is a difficult thing to do. Buying stocks in smaller chunks through a long period of time has been shown to provide much higher returns in the long run than timing the market and making 1-2 large purchases. Employing this strategy while investing is necessary for continued success. It is better to the focused on the long term and platforms such as M1 Finance provide investors free trading of stocks, bonds, ETFs within taxable and retirement accounts.
3. Stress test your Investment Portfolio – It is important to open apart your portfolio and evaluate every single company you own. You want companies with great balance sheets as they are in a much better shape to weather the storm. You also want high growth companies that you can realize the increased cash flows as the market gets back into an upswing. In investing, it is always wise to purchase companies with a wide moat as these companies are more likely to generate superior returns over the long run. Warren Buffet once said “In business, I look for economic castles protected by unbreachable moats.” Companies that have a lot of competitive advantage making it difficult for its rivals to gain market share of that industry are regarded as moats. Companies such as Apple (AAPL), Facebook (FB), and Berkshire Hathaway (BRK.B) are widely known as moats within their industries. It is difficult to go wrong investing in a moat as they hold tremendous power and are able to impact their industry in a major way through technological breakthroughs from R&D, acquisitions, and consistent cash flow generation leading to continued dominance and leadership within its sector.
4. Think long-term – As an investor, it is difficult to stay consistent given the swings and volatility in the market but they say the slow and steady wins the race. I would anchor more on the “steady” portion of that statement as being steady encourages consistency and not deviating from the strategy and philosophy employed through time while investing. Investing in the currently “hot thing” does not always pan out well for most, as seen in the recent Bitcoin craze some months ago. Bitcoin has lost over 80% of its value from its peak in December 2017. As with most things in life, there will always be something new but it is important to hash out the fundamentally sound companies that have generated consistent returns through time because at the end of the day, those are the ones left standing.
5. Always have an Emergency fund – Having 6-12 months of living expenses covered is an extremely important step to preventing major losses during a market downturn. For example, take Joe who spends $2,000 per month on expenses. This monthly expense includes rent or mortgage, utilities, food, bills, loan interest payments, entertainment, and so on. If Joe wanted to make sure he fully protects the downside then he would have $2,000 x 6-12 months of expenses covered in case a recession hits. This equates to $12,000-$24,000. Now, most Americans struggle to have this amount so they are forced to sell their homes below the market value during a recession because once they lose their jobs they are unable to cover the mortgage payments each month while being unemployed unless lifestyle changes are made. Forecasting ones misery creates that urgency and prevents costly mistakes down the road.
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6. Study the Real Estate Market – Diversification between multiple asset classes, especially during difficult times in the equities market, is key to helping preserve wealth and generating passive income. Historically, these asset classes are used to hedge against the stock market. These asset classes include real estate, bonds/fixed income, private equity, hedge funds, and commodities. Real estate is an extremely popular asset class and has been well known for decades. Traditional real estate investment requires buying and managing a property with the tenants paying rental income. Now would be a good time to evaluate the net rental yields for properties in the cities that are poised for tremendous future growth. Similar to an annualized rate of return calculation, net rental yield is used extensively in the real estate industry to evaluate the yearly performance of a piece of property. Cap Rate (Capitalization Rate) is also called the Net Rental Yield. Net Rental Yield can be calculated by taking the monthly income from a rental property and multiply that by 12. Then subtracting the yearly expense to take care of the property. Finally, the resulting number is divided by the purchase price including the closing costs. For example, if a rental real estate owner gets a monthly income of $2180 per month from a property and it requires a $880 per month to manage the property. The $880 expense per month is broken down into repairs, electricity, water, sewer, gas, HOA, and property taxes. If the property was purchased for $176,841 then the net rental yield is roughly 8.8%. In this particular case, this is a healthy number. Ideally, a net rental yield upwards of 7% is good. It is important to factor in the expense as excluding it results in a gross rental yield and can provide false implications.
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7. Be aware of the Government $2 Trillion Stimulus Package – The US government has put in place a $2 trillion economic relief plan to offer assistance to tens of millions of American households affected by the coronavirus pandemic. Its components include stimulus payments to individuals, expanded unemployment coverage, student loan changes, different retirement account rules and more. It is important to be aware of exactly what the stimulus package entails and how you can make sure you are a beneficiary of it. Most adults will get $1,200, although some would get less. For every qualifying child age 16 or under, the payment will be an additional $500. Single adults with Social Security numbers who have an adjusted gross income of $75,000 or less will get the full amount. Married couples with no children earning $150,000 or less will receive a total of $2,400. And taxpayers filing as head of household will get the full payment if they earned $112,500 or less. The US government has pledged what I would call “good debt” to small business owners. Debt is usually categorized into “good debt” and “bad debt.” Being over-leveraged means taking up too much debt especially “bad debt” to the point where it starts having negative repercussions. Taking on the small business loan being pledged by the government is something everything small business owner should apply for. There are conditions that can make the loan forgiven which in turn makes it a grant when all is said and done. The loan is also at a 1% interest rate which also sweetens the pie. In addition to the Paycheck Protection Act that the CARES Act created, small businesses can also receive relief via Economic Injury Disaster Loan program, up to a maximum of $2 million. Both the Paycheck Protection Program and the EIDL program loans can be found on the SBA’s website.
8. Eat well, sleep well, and exercise daily – Establishing healthy habits is a way to stay occupied during this downturn. When you feel well, it’s easier to be happy and successful and get the most out of life.To be in the best mental and physical state possible. It is important to get enough rest, cook some delicious and healthy meal, and exercise daily.
9. It is only a matter of time – It is unknown how long the economic recession will be but one thing is for sure, the market will recover. It is important to follow the necessary steps to make sure one is fully ready to take advantage of this situation as there is always light at the end of the tunnel.
10. I have no #10 – insert what you think about your personal situation – Everyone has a unique situation. Prior to the economic recession, I had zero debt and have always maintained a diversified portfolio which has been very beneficial during times like this. I have only realized at most a 10% decline in investment value and this has primarily been due to maintaining a 40% stock allocation all through 2019. Starting in August 2018, I was able to decrease my allocation towards stocks from 70% to 40% currently. In order to do that, I invested heavily in hard assets in the commercial real estate space mostly consisting of multi-family apartment complexes, hotels, commercial rental buildings, and single family homes.
In summary, we are in an economic recession bringing an end to the longest bull market in history. I initially wrote about the 2020 recession on August 24, 2019. When it is all said and done, there will be winners and losers. To be on winning end requires thoughtful planning and considerations through time. After that has been done, sit back, relax, and enjoy the ride!

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