Right before the pandemic began in 2020, the question I posed for all of you was: If the economy tanked, would you be ready? How about if World War III broke out?
I asked this question before 2019 was an extraordinary year for returns. Something bad was bound to happen, and it did!
Let's do a post-mortem and review of this post.
If The Economy Tanked, Will You Be OK?
The U.S. is in the midst of its longest economic expansion in history.
But when the Federal Reserve cuts interest rates, that’s usually a sign that the economy is slowing down — or worse. After raising rates nine times from 2015-18, this year the Fed has reversed course, cutting the short-term federal funds rate three times.
Boom Bust Cycles
Another worrisome trend: New York Fed data shows the unemployment rate for recent college graduates (red line) has been inching upwards this year, suggesting employers are skittish about growth.
Booms and busts of the business cycle are pretty much accepted as a necessary tradeoff of our free-market, capitalist system — which has weathered seven recessions since the 1970s. At the very least, it is clear that growth is slowing in both developed markets and emerging markets around the world.
Most Felt A Recession Was Coming
In a recent CNBC/SurveyMonkey poll, nearly two-thirds of Americans said they think it’s likely we’re headed for a recession next year. Close to half of those who see storm clouds on the horizon are preparing for it by cutting back on household spending and paying down debt.
“This refreshing prudence on the part of the U.S. households is, of course, exactly opposite of what macroeconomists at the Fed — as well as incumbent politicians who view lower rates as enhancing their re-election prospects — want to happen,” says former FDIC Chairwoman Sheila Bair.
Rate cuts are designed to encourage people to borrow and spend. But this time, Bair says, “it looks like American households have learned their lesson, even if Washington has not.”
The downturn has obviously arrived in 2020 thanks to the coronavirus pandemic. It unfortunately came sooner than most of us had all expected. As a result, this post is more important than ever.
It's always a good idea to constantly be managing any outstanding debt you’re carrying, whether its credit card balances, student loans, or a mortgage.
If the economy tanked, make sure
- You’re not paying a higher interest rate than you can qualify for
- Most of your monthly payment is going toward paying down principal, rather than interest charges
- You’re prioritizing your loans with the highest interest rates
- You have a good cash balance equal to at least six months of living expenses
Let’s look at some techniques you can use to whip your credit card, student loan, and mortgage debt into shape and get better prepared for the next recession. If the economy tanks, you want to be prepared.
Here's how to make lots of money in the next economic downturn. Economic downturns occur every 5-10 years.
Refinancing Student Loans
According to the Federal Reserve, in 2019 the average college debt among student loan borrowers in America is $32,731. This is an increase of approximately 20% from 2015-2016.
Most borrowers have outstanding student loan debt of between $25,000 and $50,000. But more than 600,000 borrowers in the country have over $200,000 in student debt, and that number may increase.
Student loans are good candidates for refinancing in a falling interest rate environment, or at any time your creditworthiness has improved.
Rates on federal student loans are fixed once you take them out. But at the start of each academic year, rates for new borrowers are adjusted to take into account the government’s cost of borrowing.
Not only that, but grad students and parents pay higher rates. So it’s not unusual for many borrowers to be paying 6%, 7% or 8% interest on federal student loans.
In a falling interest rate environment, many graduates who have put together a history of earnings and credit can qualify for better rates from private lenders like SoFi, Citizens Bank, College Ave, and PenFed. Rates on student loan refinancing have also been falling.
But check rates with multiple lenders, and keep in mind you’ll lose access to federal programs like income-driven repayment if you refinance government student loans with a private lender.
If you’re refinancing a mortgage, fees can cut into the savings you can achieve by refinancing. But there are no prepayment penalties on student loans.
Refinancing Mortgages
There’s been a rush to refinance mortgages in 2019 thanks to a dip in long-term rates. But keep in mind that the Federal Reserve played a role in keeping mortgage rates down after the 2008 financial crisis.
Now the Fed wants to back out of its role in funding mortgages, so mortgage rates could head up if private investors don’t pick up the slack.
When refinancing a mortgage, you’ll have to measure the savings you can achieve if you’re able to get a lower interest rate against fees charged by the lender. You can use a “break-even” calculator to see how long it will take for your savings to cancel out any fees.
Financial Samurai recommends refinancing if you can break-even within 24 months or less and own the house for five years or more. Alternatively, look into a “no-cost refinance” where all the fees are baked into the refinance.
There's also a triple benefit to paying off your mortgage early if you don't want to refinance. You will gain huge cash flow, which is great for living.
Consolidating Credit Card Debt
The good news about credit card debt is your interest rate is typically indexed to the prime rate, and the prime rate follows the Fed’s short-term interest rate adjustments closely. So when the Fed is in the mood to cut rates, your credit card rates will often come down, too.
But a funny thing happened when the Fed was raising short-term rates from 2015 through 2018. Long-term rates — on government bonds, mortgages, and even personal loans — failed to keep pace. For a while, we had an inverted yield curve, when long-term rates defied logic, and were lower than short-term rates.
An inverted yield curve can be a warning signal that a recession is looming. But freakishly low long-term rates also create an opportunity to consolidate credit card debt.
At the end of the third quarter of 2020, the “spread” between interest rates on credit cards and personal loans hit an all-time high. People carrying a balance on a credit card were being charged 16.97% interest, on average. But the average rate on personal loans was only 10.07%
Take Advantage Of Lower Personal Loan Rates
This huge spread has borrowers scrambling to refinance credit card debt by taking out personal loans at lower interest rates, potentially saving thousands of dollars.
As Financial Samurai has written, paying the average credit card interest rate will likely keep your poor forever. With the spread between the average credit card interest rate and the personal loan rate so large, it behooves those with credit card debt to consolidate their loans.
If you’re interested in pursuing this strategy, it’s important to get actual rates from multiple lenders. Competition for borrowers is fierce, so shopping for the best rate can pay off.
To refinance your higher credit card debt, click here to get some real personal loan quotes from multiple private lenders. Take advantage of the biggest spread in a long time.
Disclosure: Credible Operations, Inc. NMLS# 1681276, “Credible.” Not available in all states. www.nmlsconsumeraccess.org.
Always Be Prepared If The Economy Tanked
By taking advantage of lower rates and prudently paying down debt, you will be in much better shape if the economy goes into a recession. Surviving a recession is all about having enough cash flow to make it until the inevitable recovery.
If the economy continues to roar higher, you'll also feel great knowing that you've optimized your debt while concurrently making greater returns and optimizing your earnings power.
At the end of the day, you always want to create a heads you win, tails you also win scenario, no matter the economic environment.
Update Dec 1, 2020: It is crazy that the economy tanked hard. Harder than anybody could have ever imagined due to the coronavirus pandemic. However, here we are with stocks and real estate prices higher than ever before. As the economy tanked, wee took advantage of lower interest rates and refinanced our debt. We also ended up buying a lot more assets with cheap money.
Update 2023: We went through a bear market in 2022, but now there are buying opportunities. I'm personally going shopping for more private real estate in 2023 and beyond.
Invest In Real Estate More Strategically
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile.
The combination of rising rents and rising real estate prices builds tremendous wealth over the long term. Meanwhile, there are more ways to invest in areas of the country where valuations are lower and net rental yields are higher thanks to crowdfunding.
Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. The real estate platform has over 300,000 investors and manages over $3 billion.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.
Even if the economy tanked, real estate will continue to pay steadily as it is a sticky and defensive asset. The key is building more cash flow.
Great article and insight. Very appreciative of the discussion.
I noticed aa guest post from an Air Force Captain about the financial benefits of joining the military, circa 2015 or so.
Great post and I’d love an opportunity to expand that conversation, as a lot has changed in the “military benefits” and financial conversation since then (for service-member and retirees).
It’s an under-served segment of the market who need additional information and education on their path to financial independence.
Would you entertain a few email exchanges and perhaps a telephone discussion with me? Kind regards, JHS
Sam,
I’m getting ready for the recession. I’ve been accumulating cash for several months from my income, and I’m selling all my stocks this week. I’m ready to make a killing once the market crashes. I’m just hoping I don’t get laid off when the recession hits as I’m not quite financially independent. I just need a few more years of my income to get there.
Good luck! Nobody can perfectly time the market. At the same time, you can never lose if you lock in a gain!
I plan on doing exactly nothing different. I owe nothing on any of my properties. I’ll just keep working and saving. I’m about at the point where if I lost my job I would breathe a sigh of relief. All except for the medical insurance part. While do-able, it would still be painful.
I am a little worried about this. My husband and I make decent wage(Both early 30’s) and a baby on the way.
We have decent savings(combined) but nowhere close to what we hope we would get in return. Instead we bought a house at the peak market and made some mistakes on the investment front(lost tons of money shorting stocks), and I am not sure how to prepare ourselves for the next recession.
What are your suggestions Sam? My husband and I genuinely want to have “f u money” lol (my husband’s word, not mine) by the time we are in our 40s.
The media has been hammering the recession drum all year, rooting for a downturn to stymie any hopes of reelection. The Fed is full steam ahead on QE4, and has taken the money printing genie out of the bottle once again. This time last year the market was in a major correction, after the Fed raised rates in excess of what the economy could bear. Now the central banks are easing and today’s blowout unemployment numbers prove that there is no reason to believe a recession is anywhere in sight. Remember what President Clinton said…”ignore the headlines and focus on the trend line.”
Sure, an adjustment will come sooner or later, but no one can time them. And it’s like flipping a coin in some respects. Some people, after watching a coin flip result in heads, six times in a row, will bet heavily against it happening again, believing the odds to be in favor of a tails result on the next flip.
Unfortunately for them, that is not the way statistics work. That next toss is as likely to produce heads as tails, regardless of what has gone before. So upping your bet on that basis is insupportable.
Choose how much you need to earn, how much you can afford to lose, figure the risks appropriately. You cannot predict the market, although we have to presume that, over a long enough period of time, the market itself will go up in value, even though some individual issues do not.
There may be a correction in 2020, or there might not. It may be small, it may be large. But I suspect if it occurs it will owe much to investors who are betting against prosperity, rather than merely trying to invest carefully and limit their exposure to poor choices.
My personal belief, is that automation is going to be extremely good for the markets in the coming decade. It increases the value of capital, which is what investments provide. At the same time, the proportion of wage-based earnings, relative to capital based earnings, will be falling, and that is very bad news for people living paycheck to paycheck and that have no investments. That, in turn, is ultimately bad news for consumer spending, the basis for much of our economy.
The real problem, I would guess (note the word guess), will be around 2030, when the increases in profitability due to automation can no longer stay ahead of the drop in consumer spending. I hope I’m wrong, but I suspect the US government, among others, will wait too long to make timely changes. At that point there will be too much investment money chasing too few rewarding investments.
That’s the kind of thing that could drive the marginal income tax rate back to 90%. Might want to relook at those Roths before then, but plan ahead, it’s difficult to contribute to them effectively except over a long period, and that’s only 11 years out.
This is the reason why most people are not happy as they get older – you worry about things you have no control over such as the “World Economy”.
All strategies FS suggested in article are helpful and should be automated into your financially game overtime without thinking about it – but, it won’t help you with the calamity similar to 2009.
Most of you come to FS with the desire to be financially educated, but you are not prepared for the lessons because you have not established 2 fundamental and critical numbers –
1. Annual Living Expenses
2. Financially Independence Target
These 2 fundamentals must be tailored made for you and your family – neither from your neighbors nor your friends.
Regardless of your incomes, once you have these two numbers established – make sure they are they are mathematically in multiples of each other by 25. Meaning ALE = FIT/25 or FIT = ALE x 25.
For those who enjoy the pain of competition like FS – please use 33 or 50 as multiples.
Once you have done your homework and have these numbers – do subscribe to FS for additional financial lessons to fine tune your financial game plan going forward.
Meanwhile, train yourself live on the Annual Living Expenses you have personally established for you and your family and ignore the HIGH and LOW of the market.
Happiness is more than money – yet, daily, weekly, monthly and yearly the market’s random movements determine your sentiments and direct your behavior.
There are other areas of your life which are in stagnation that need the investments of your time and resource – this is why many seemingly wealthy people are depressed with their lives.
Strive for progress because Life feeds on progress – without progress, life will wither and drain out of existence.
I am always leery about inferring anything from “data”. Who knows “why” something is happening. It is just as plausible that recent college grads are not getting hired due to the decreasing value of college degrees. Or maybe it is the recent college grads expectations for their first jobs out of college that leads to their unemployment and waiting for a better offer. Perhaps something else we don’t recognize?
I’d bet though that if we hit a recession like the housing crash the country/people as a whole are NOT prepared for it at all. It would be worse than last time… though hopefully not turn into mad max times. Anything small would be business as usual.
It’s definitely interesting how everyone knows the market is a ticking time bomb yet people don’t take the necessary steps to prepare their investment portfolio for it. I liked your earlier article on CD laddering/step stooling, which will allow you to reassess and re-invest your freed up capital at each stage of expiry.
In the late stages of a market cycle such as we’re in now I think it’s important to take a look at your investments and see if you have the room to diversify into uncorrelated assets such as Gold (which traditionally ticks higher during market turmoil- allowing you to use the proceeds to buy more stocks at lower prices) or even moving some money into more boring investments like time deposits or certain bonds (if willing to hold until expiry).
Would be curious regarding your thoughts for how to increase liquidity to take advantage of assets on sale after an economic slowdown/correction/recession. From my memory in 2008, even high quality borrowers with good credit scores and low debt levels had trouble getting loans to take advantage of distressed seller.
Are you simply raising cash, opening lines of credit, finding other investors with cash/access to credit or doing something else so you are able to buy assets at attractive prices?
My suggestion is to sock it away now for use later..
I for one recently completed a cashout refinance at 3.75% and stashed away an extra $400k for this very reason. Credit (cash) hard to come by even with perfect credit profile during poor economic times.
High yield savings currently 2.1% so the spread is little compared to opportunity cost missed when in a recession with no quick availability to cash.
Recession doesn’t happen? Simply pay back down the mortgage with the cash that was taken out.
The key is to be ready cash in hand.. we can all imagine “if” we had tons of liquidity in the 2009-2011 period.
What do you plan to do with the $400,000 in cash? Further, when will you determine whether a recession doesn’t happen to pay down the mortgage?
It’s not a bad idea to get cash out if you strongly believe a recession is imminent. However, $400,000 seems like a lot of money.
I am keeping my cash in an ETF. Ticker is MINT. It pays 2.5%.
Prepare for a slowdown? Plenty of cash on hand, mostly to shop equity and real estate bargains in the recession aftermath. I sleep well at night. Cash and limited debt give life options.
Yes, a dip is coming and you can see it in the behavior of businesses as well as regular everyday people and their spending habits.
As an example, when we look at spending habits of regular every day people, before the 2008 crash, people were buying homes at grossly inflated prices assuming the price of the home would only continue to increase and many didn’t understand that if we’re going through a seller’s market, they would get hurt in the event of a major recession if they bought a home above their budget. I see this same pattern happening now where homes are bought a week into being on the market and at much higher prices in comparison to 3 years ago. About 1 mile from me, in the less safe part of town, you see houses which were once priced at 150K or 200K in 2017 going for 25% more than they did in 2017, but the crime rate has not gotten any better so why would they pay more for a bad school system, bad roads, unsafe streets and homes which are not worth the price tag? Could it be that buyers are experiencing the same hysteria they did before the 2008 crash? Possibly…let’s see what unfolds after mid-year in 2020.
What is your advice for someone looking for a home to buy in this market? We seem to be in a catch 22 because if we buy now, we may end up with a 20% correction, and if we don’t buy, we may miss the low rates. However, like you said before, you can refinance for a better rate later, but you cannot change the price tag on the home you bought.
No debt except my primary mortgage which is ultimately a hedge against inflation. Given that the Fed has become more adept at managing the money supply I’m skeptical of inflation ever returning. I do own bitcoin though not for inflation reasons; but as an escape hatch.
I was surprised to read your recent article that now is still a great time to buy real estate. Now a couple weeks later you warn about a recession coming which I have felt as well. It’s been over 10 years since the last major correction or crash, we are due for another one. Probably won’t happen until after Trump gets re-elected. my retirement plan is buying Bitcoin on the dips and it has changed my life for the better in The last 5 years. almost anytime you buy Bitcoin would have been profitable year-over-year other than buying on the peaks. Eventually hyperinflation will hurt all the savers of any government currency.
Remember what happened to real estate prices after the 2000 dotcom crash?
There’s always a bull market somewhere. And there’s always relative outperformance somewhere.
GL on your bitcoin!
Yes but I bought a home to flip in 2007 and lost my shirt in 2008 when I sold it, 150k loss! I’ll never forget what a sucker I was to listen to my friend and realestate agent, he was only thinking of his own profits… There may not be a bull market for 2-3 years as prices are declining now…so suggesting to your readers that buying property in the most expensive city like SF seems so foolish to me. My older experienced realestate friends are telling me to sell my home soon if I want to take profits. They expect a downturn.
Ouch. Sorry to hear.
What if you had held on until now? What is the value of the house?
What if you had bought the house in 2008-2009 instead? Prices have been weakening already.
Finally, why sell in 2008 after buying in 2007?
Thx
It was a second manufactured home in my Park where I lived. I couldn’t afford to keep carrying the second home mortgage. I could not run it out for close to the mortgage and tax payment. Today that home is not much more than it was when I sold it, I might have broken even by now. Thank God my Bitcoin did much better and made up for all the losses of my lifetime. I’ll buy property again but not until the next crash or correction, that’s my lesson learned. Buy low sell high. Keep things simple. Commercial property seems more favorable in growing areas.
Really not much difference in my life in a recession vs a bull market.
No real debt except half a mortgage, jobs aren’t tied to the economy and not liquidating stocks for a long time so won’t take any realized losses.
The benefit would hopefully be a softening in housing prices so I can buy more real estate.
The problem it seems we’ve found when you pay off your mortgage…it’s hard to get the money back out. Banks are only willing to give you a small percentage home equity loan. So you have to make sure you have plenty of money in a spare savings vehicle that pays a decent ROR for hard times so you can sleep at night. What is your advice on this Sam?
I feel fortunate to be free from student loan debt and to be able to pay off my credit card in full every month. But there was a time when I had to really watch my spending so I could make my payments without getting hit with extra interest and fees.
Refinancing my mortgage has made a huge difference in my larger debt management as I got older and its thanks to Financial Samurai that I was motivated to go through the refinance process multiple times over the years.
It’s become quite a pita to complete mortgage refis now with the amount of paperwork and back and forth follow up but it’s truly worth the time and effort for the savings.
Hopefully we won’t go through another major market correction but it wouldn’t surprise me if we do. Gotta stay on top of debt and manage expenses wisely before, during, and after if and when it happens.
I do think it is smart to optimize any debt you have in such a low interest rate environment.
This is where those who are completely debt free, like myself, get penalized as your savings accounts/emergency funds start earning less interest (my online saving account has gone from a 2.2% rate to currently 1.8%.
I would love for the economy to keep trending up like it has for the past decade but know at one time there will be a correction/recession. I de-risked my portfolio because it just so happens to coincide with the 5 yr window for my planned retirement