Don’t Worry About A Downturn Or Stock Market Selloff—Do This Instead

Investors are worried about an economic downturn, perhaps even a recession. The stock market is coming off two blistering years and the headlines from Washington are hard to ignore. Don’t fall victim to fearmongering or try to predict when you can prepare instead. So if you’re wondering what you should do out of concern for your investments, personal finances, or a looming recession or stock market crash: take a deep breath, put the current context into perspective, and focus on what you can control.

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.” – Peter Lynch

A quick history lesson on recessions and market downturns

Before discussing what investors should – or shouldn’t – do with their finances if they expect a recession or market crash, it’s important to zoom out and get some long-term perspective. Markets and investors have notoriously short memories, but the U.S. economy and markets have overcome many periods of uncertainty and economic pain.

Recessions

It’s important to understand that every economic cycle ends in a recession. So if we’re not in a recession, technically, we’re always getting closer to one. Since 1950, there have been 11 recessions, lasting ten months on average.

That means historically, the U.S. experienced a recession every seven years on average. So the reality is, investors should expect negative economic events like recessions to occur periodically throughout their lifetimes, and use that knowledge to plan ahead.

Market selloffs

There are many terms to describe pain in the financial markets: bear market, correction, market crash, selloff, dip, etc. Although some of these terms have meaning, the point is that markets go up and down every day, but the longer you invest, the more likely you’ll make money. Investors also may not recall (cue that short-term memory!) how much stocks tend to fluctuate each year.

In fact, the average intra-year decline for the S&P 500 is over 14%! But despite short-term selloffs, on a calendar year basis, the stock market has historically been positive 75% of the time.

Trying to predict the next market correction, recession, etc. isn’t a worthwhile endeavor. But taking steps to help ensure you’re always reasonably prepared for any type of economic uncertainty, personal financial crisis (loss of a job, divorce, etc.), or downturn in the financial markets is just prudent financial planning and investing. More on that next.

Prepare your finances for a downturn before there is one

There’s no point in trying to market time the next recession or market correction. But, since we know these things will happen again, eventually, focus on what you can control by taking steps to prepare in advance. By getting ready, and staying ready, you can (hopefully) avoid any unnecessary headline-induced stress. That said, preparation isn’t a magic bullet. A recession or prolonged market selloff can still leave investors with some financial bumps and bruises. Unfortunately, investing involves risk, so that’s just part of the deal.

Whether you need to make a change depends on your current financial situation. If you don’t have a good handle on your finances, now is always a good time to get organized.

All-season financial checklist

While not an exhaustive list, these are some key financial planning items everyone should tackle.

Keeping the right amount of cash. Cash is always a hot-button issue. Investors almost always have way too much or far too little. As a general rule, one income households should have three to six months of essential expenses in a savings account, with two-income families needing double that amount. Not having enough can be disastrous if caught flat-footed. Having too much is no way to build wealth.

Figure out your spending. I’ve concluded that at any income level, no one really knows what they spend. Some can’t even suggest a ballpark. Yes, tracking expenses is annoying and you may not want to know. But if you don’t know what your lifestyle costs, how will you know what you need to maintain it in retirement?

Stress test your retirement plan. Stress testing a financial plan is crucial to help ensure retirees won’t run out of money under different conditions in the financial markets. Most retirement calculators are straight line projections, where the portfolio never deviates from the stated return. Notably, this ignores the reality that returns will fluctuate each year — sometimes significantly. Even if actual average returns meet targets over time, market volatility can still derail your retirement plans. That’s where the Monte Carlo analysis comes in.

Assess your financial flexibility. If there’s an economic downturn, stock market decline, or you suddenly lose your job, having high fixed expenses is a recipe for trouble. Even if you wanted to make cuts, you might not be able to, at least not quickly. Having financial flexibility gives you another lever: the ability to adapt if needed.

Check how you’re invested. As far as investing goes, bad ideas include: going to cash out of fear and making changes solely because you’re hypothesizing [insert concern you can’t control] is bound to happen. That said, it is important to periodically review your accounts to ensure you’re properly diversified and are taking on the right amount of risk. Diversification isn’t a magic bullet, but it’s typically the best defense in volatile markets. Bonds are typically a ballast in a portfolio, and they tend to perform well during recessions. There’s a lot that goes into a proper investment strategy, but one major key to success is about time in the market—not timing the market.

Review your insurance coverages. Your life changes, so too should your insurance coverages. For example, when people are just starting out with young kids, they may have substantial life insurance needs. But if your financial situation changes or the kids are now independent, reconsider whether you still need that expensive whole life policy. Also review your property and casualty coverages. For example, after a home renovation, homeowners may be underinsured. Also, if you don’t have an umbrella policy, there better be a good reason why.

Focus on what you can control

We can’t protect ourselves against every unknown or prevent life’s certainties from happening. But if you do the work, stay on top of it, and build in enough margin for the uncontrollable, outside events shouldn’t have an outsized impact on your life.

Navigating economic uncertainties like recessions and market downturns requires a shift in focus from prediction to preparation. Instead of attempting to time the market (or the recession), strengthen your financial foundation. By concentrating on the controllable aspects, you’ll be in a better position to weather any financial storm and achieve long-term financial stability.