Recessions Lead People to Make Big Money Mistakes
Recessions Lead People to Make Big Money Mistakes
After relishing one of the longest bull markets in history, millions of millennials and young investors, myself included, are getting our first real taste of a severe recession — a scenario that often leads to costly, knee-jerk financial decisions.
A global pandemic has made it unclear when routine socializing and in-person events can continue, dealing a devastating blow to many industries. Even a $2 trillion relief package in the US hasn’t provided an adequate safety net. Not to even mention the double-digit unemployment numbers we’re seeing.
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 of us fairly fresh to managing such a downturn, it's critical to know which mistakes to avoid. For this insight, I turned to the expertise of eight certified financial planners. Here are the worst money moves they’ve witnessed clients make in a recession.
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 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.”
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% less than if he had simply stayed invested.
Most planners have some version of this tale. Instead of moving money from your brokerage to your paltry-interest-rate bank account, first consider rebalancing your investments to a more conservative portfolio.
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% 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 capitalize on cheaper investments and lower interest rates if you are looking to borrow money,” says Ngo.
That being said, it’s important not to be overly bullish on borrowing.
Borrow to invest in the stock market. In an effort to assuage the public’s fears, money media personalities and personal finance experts alike will push the mantra of a recession being a “fire sale” on stocks or a chance to snag cheap real estate. There is of course 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 and capitalize on the down market, advises Nikki Dunn, CFP and founder of She Talks Finance. 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 (e.g., maintains liquidity, does not carry high-interest debt and has reliable income), but borrowing money at 10 to 15-plus percent because you think you can double your money is highly inadvisable,” says Anatasio.
The focus on ramping up risk instead of de-risking investments is also a move that may be unique to this recession, says Maureen Wright, a financial advisor with Savant Capital Management, because there is access to investment tools and technology (e.g., micro-investing apps and fractional shares) that wasn’t available during the 2008-2009 recession.
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 CFP at Brunch & Budget. If the debts accumulate and get to an overwhelming place, however, then it’s important to seek help.
Not seeking 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.”
Weston points out that right now people have unprecedented access to forbearance programs from lenders, which can buy you more time to pay back debt. But if you’re making a bankruptcy decision, speaking to an attorney can help you emerge from in the best shape possible.
Make panicked choices instead of proceeding slowly. One of the most painful parts of the pandemic and quarantine is this pervasive feeling of the unknown. We want so desperately to revert back to “normal” and feel some semblance of control.
“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 Center.
Writing all of my concerns down did help me assess them more objectively. These included earning a variable and volatile income, living in an expensive area and having an enormous medical bill if my husband or I needed to be hospitalized due to Covid or any another health issue. Even though we have decent health-care coverage, it often feels we’re one medical issue away from major debt — and the same is true for many American families. Getting these worries out of my head allowed me to model budgets for various situations. I also reduced the salary I pay myself in order to ensure my business reserves could last longer if it took a while to rebuild my income streams.
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.