After relishing one of the longest bull markets in history, millions of millennials and young investors are getting their first real taste of a severe recession – a scenario that often leads to costly, knee-jerk financial decisions.
It’s a safe bet to say the aftershock of the Coronavirus Recession will rival, if not outpace, that of the Great Recession. And for those fairly fresh to managing such a downturn, it’s critical to know which mistakes to avoid. For this insight, I asked eight certified financial planners about the worst money moves they’ve witnessed clients make in a recession.
1. Stop contributing to retirement plans
A common misstep among investors of all ages is to panic about the market downturn and press pause on investing, including on recurring contributions to retirement plans.
Before you make any changes to your asset allocation, or even consider withdrawing funds, it’s important to consider what your goal and investment strategy is, advises Inga Timmerman, an associate professor of finance at California State University Northridge and owner of Attainable Wealth.
“If you are 35 years old, there is no need to change your investment allocation in a retirement account you cannot touch until 60,” says Ms Timmerman. “If you decide to make the portfolio more conservative, make sure you have a plan – an exact plan – on when to come back, rather than a general idea of when the market starts to recover, as it is impossible to know that.”
2. Move investments to cash
As a self-employed person, my income got rocked in March and April due to the pandemic. Speaking engagements were cancelled and media companies began to freeze freelance budgets. A typically bullish investor, I admittedly had a moment of panic about not having strong enough cash reserves. Thankfully, I left well enough alone and was rewarded when the market bounced back. But many people don’t stay put.
Lauren Anastasio, a certified financial planner at the company SoFi, told me about a man who was advised by a broker to sell out of his portfolio. The investor was in his early 60s and sold at the bottom of the market in March. He didn’t reinvest the money, so he missed out on the rebound and has about 25 per cent less than if he had simply stayed invested.
Instead of moving money from your brokerage to your paltry-interest-rate bank account, first consider rebalancing your investments to a more conservative portfolio.
3. Focus on short-term returns
According to Helen Ngo, the CEO of Capital Benchmark Partners, clients tend to exacerbate their panic by focusing on their account’s quarterly or monthly statements, instead of evaluating the overall performance.
“This was very evident in March and April when they received their quarterly statements and saw a 20 per cent drop in their accounts,” she says. “Had they looked at their performance since inception, it’s not so bad.”
She advises clients to keep in mind what type of account they have and the accompanying time horizon. “If it’s a five-plus year time horizon, a recessionary period is an opportunity to capitalise on cheaper investments and lower interest rates if you are looking to borrow money,” says Ms Ngo.
4. Borrow to invest in the stock market
In an effort to assuage the public’s fears, money media personalities and personal finance experts will push the mantra of a recession being a “fire sale” on stocks or a chance to snag cheap real estate. There is some truth to this sentiment, but it’s not a reason to over-leverage yourself.
It’s often a mistake to take out a home equity loan, high-interest personal loans or use cash advances from credit cards to try to capitalise on the down market, advises Nikki Dunn, CFP and founder of She Talks Finance. Ms Dunn tells clients that if we’re in a recession, then asset prices, including a home, can decline, plus the security of your job could be in question.
“Leveraged investing can make sense for those in a strong financial position but borrowing money at 10 to 15-plus per cent because you think you can double your money is highly inadvisable,” says Ms Anatasio.
5. Focus on aggressive debt repayment
Planners also advise against using up or reducing your cash resources in order to pay debt faster than required. In a recession, it’s best to stick to the minimum payment due.
“Once you have made those debt payments, that money is gone. Hold onto savings in case they are needed in the event that you lose income,” says Samantha Gorelick, a certified financial planner at Brunch & Budget. If the debts accumulate and get to an overwhelming place, however, then it’s important to seek help.
6. Not seek assistance
“One of the biggest mistakes is not consulting a bankruptcy attorney if you’re struggling with debt,” says Liz Weston, a planner and columnist for NerdWallet. “People continue to try to pay their bills long past the point where they should have thrown in the towel, or they try to settle their debts when those debts could be legally erased.”
If you’re making a bankruptcy decision, speaking to an attorney can help you emerge from it in the best shape possible.
7. Make panicked choices
One of the most painful parts of the pandemic is this pervasive feeling of the unknown.
“The biggest advice I give people in uncertain times is to take all of the things going on in your head and write them down,” says Jude Boudreaux, a senior financial planner with The Planning Centre.
8. Forget about history
While no two recessions are alike, it is critical to remember that market downturns are a normal part of economic growth. The Great Recession was followed by the longest bull market run in history that bore witness to new all-time highs for the Dow Jones Industrial Average.
Even the most experienced investors are likely to feel a twinge of panic during a recession, but it’s critical we make financial moves from a place of knowledge, not emotion.