How to Prepare for an Impending Recession as an Investor
There’s no denying that 2022 has started off more turbulent than most of us would have predicted. Inflation is at a 40-year high. Russia has gone to war with Ukraine. The stock market has been volatile (according to Time, Inc, “40% of the 3000 Nasdaq stocks have lost 50% or more in the past few months”). Nearly half the crypto market has been wiped out.
Not to focus on the negative, but this is the reality of the world we are living in right now. Whether you’re an investor or not, you may be wondering what the economy is going to look like over the next year. You may have even heard rumblings of the dreaded “R” word: Recession. Recessions are an inevitable part of our current modern capitalist economy. Given the current signals, it would not be surprising if we entered into one at some point this year.
Don’t let this scare you into hiding money under your mattress, though. In this article, we’ll explain what we’re seeing in the current economy and why signs point to recession, how it can impact different asset types, and what you can do to prepare. Remember, we are not financial advisors and this is not financial advice because we do not know your personal financial situation. This is for educational purposes to help you be a more informed investor.
Let’s start with inflation.
What Does Rising Inflation Mean, How Do You Curb It, And What Does That Mean For The Economy?
If you read the investopedia article linked above about how recessions happen, you’ll get a better understanding of how inflation is also linked to these economic business cycles. Inflation generally means that there is too much money in our economic system. Think about how low interest rates have been on mortgages, how easy it has been to get a business loan, and how much stimulus money has been sent out by the government over the past couple of years.
Rising inflation is not politically favorable - consumers don’t like it when they can no longer afford to buy a pound of ground beef at the grocery store. Rising inflation tends to signal that the economy doesn’t need to be “propped up” any longer. Most of us don’t feel that we are living in a booming economy given the challenges of the pandemic over the last two years, yet we’re experiencing high inflation which typically indicates that we are. Unfortunately, the U.S. government cares more about tapering down inflation than how the economy is actually doing. Which means they are going to be working to reduce that inflation with the tools they have available.
So, how do you curb inflation? Through a practice called quantitative tightening, which is essentially aimed at reducing the overall supply of money in the economy (to combat the fact that there is too much money currently in the economy). This practice is done by the Fed Reserve by not buying back Treasury bonds, increasing federal interest rates in the short term, and providing less government backed lending. Higher interest rates and less lending options mean less loans being taken out.
How Does Curbing Inflation Impact Investment Markets?
At this point, you are probably wondering what all of this means for your investments. Let’s talk about the stock market first. The stock market is made up of businesses. Rate increases by the Fed tend to negatively impact those businesses because it limits their activities (think less government lending and higher interest rates on loans they need to conduct their day to day operations and expand). This, coupled with the global supply chain issues induced by the pandemic and uncertainty in Eastern Europe are what is driving a lot of the volatility we are seeing in the stock market recently. We don’t believe this is likely to change in the near future given the signals, but this is what stock investors need to be weighing as they look at their investments.
Next, we’ll address the real estate market. Remember that the residential market is different from multifamily (larger apartment complexes). Single family home prices are similar to stocks in the sense that they are based on speculation of how the surrounding market will perform. In addition, when interest rates go up, mortgages get more expensive so less people will buy homes because they don’t want to pay the interest on that loan or they can’t afford the mortgage at the higher interest rate.
The impact on multifamily real estate is a bit different. People always need a place to live. If people are getting priced out of home ownership, they will turn to rentals. This is why even during recessions, you still see cash flow coming in from those who own apartment complexes. While rate increases will impact commercial real estate loans as well, investors can adjust for these increases in their business plans. How? By underwriting deals more conservatively and doing stress tests to ensure you can still meet your debt obligations even if interest rates go up. If you have proper cash reserves and enough cash flow coming in then you will be able to withstand changes in rates.
How Can You Prepare For An Impending Recession As An Investor?
Review your asset protection vehicles and ensure you eliminate any unnecessary risk in your investment strategies
Consider adding precious metals to your portfolio, which tend to maintain their value during times of inflation
If you are going to invest because you see a recession as an opportunity to make money, make sure you have liquidity. You can do this by increasing your credit lines and access to credit when needed
If you own real estate, consider refinancing now to lock in a lower fixed interest rate
When looking to invest, focus on cash flowing assets like multifamily real estate. Whether you are an active investor or a passive investor, it’s important to make sure that you or whoever you invest with have ample cash reserves and monthly cash flow coming in to handle turbulent times
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