How to prepare for the next recession?

For the past few months, I am seeing some excesses in the market that has brought back memories of past boom+bust cycles. For example,

  • A 2bed/2bath condo sold for a neat $1mil,
  • A 3bed/2bath townhome list for $850K and sell for $1.2mil…I am not joking about this ūüėź
  • I saw many people jumping in to buy $70K cars
  • I saw people bid more than $100K over the list price to buy a very old home
  • ……

The above observations remind me of previous boom cycles and I felt that it was time to revisit lessons learnt from past boom+bust cycles. Hence this post. Hope it is useful for you. If you have lessons of your own to share, please do so…it would be much appreciated.

Boom+Bust cycles

I have faced two official recessions OR you can say a few bubble-pops in the last two decades of my life.

  • Economy was doing comes the¬†dot-com bubble pop in 2001
    • This was officially a recession
  • Economy was doing comes the market tank due to the Iraq war
    • This was officially not a recession, but job losses were the same…..
  • Economy was doing comes the real estate bubble pop in 2008
    • This was officially a recession

Before each recession, there is a period of bubble formation OR economic prosperity….pick your poison ūüôā¬†One could go back¬†in US economic history and one would find the same repeated pattern of BOOM and BUST cycles.

  • 2004 to 2007: Boom time; Bubble pop in 2008-2010
  • 1994 to 2000: Boom time; Bubble pop in 2001-2003
  • 1983 to 1991: Boom time; Bubble pop in 1992-1994
  • ……..

The current Boom cycle has been on from 2010 onwards…I.e. we are more than due for a Bust real soon…..can we benefit from this knowledge? If you are interested in how I plan to benefit, please read on.

What did I see or not see during these cycles?

  • For the 2001 bubble pop, I had no idea this was coming…I was a finance newbie and really did not even know what 401K meant. But, I did see a lot of job losses around me, close friends getting hurt bad and I myself barely scraping through..more luck than anything else….it was a very stressful time.
  • For the 2008 bubble pop, I could see it coming and did take some decisions like moving to a more stable job, creating an emergency fund, etc. But, I did not predict¬†the severity of the recession….again, it was a lot of job losses around me and it was again a very stressful time. I was fighting so hard to retain my job and stay afloat that benefiting from it did not come to my mind.

But, since I was no longer a financial newbie, I was fortunate to be around people who, on hindsight, proved to be financial geniuses. I was not smart enough to financially benefit form the lessons at that time, but I plan to do so in the next recession. Here are some examples of a common patterns I saw during the boom+bust cycles.

  • A¬†person I know¬†dumped $150K into the stock market, in the worst of the 2008 bust cycle and by 2014, he had more than doubled…infact almost tripled his investment. At that time, I thought he had nerves of steel to do that but on hindsight, he was just making use of the recession. He has now officially¬†retired and working part time just for the social connections.
  • A person I know, a financial newbie, bought a home in 2008, under pressure from family since a baby was on the way. She really hated the idea of buying and came up with all financial reasons not to…but, a relative who happened to be a real estate agent convinced her¬†otherwise and ¬†even dropped the commissions for the purchase. Her house is now $500K past the purchase price and she stopped working to spend time with the baby. She now looks like a financial genius and the relative loses no chance to rub it in.
  • A couple of people I know bought houses at the peak of the boom cycle in 2000, 2004 and 2007. They went through a lot of suffering with undervalued houses…especially with the threat of job losses hanging over their head. It took many many years to break even and some have not yet done it still.
  • Job loss means loss of two important things as well: Health insurance and Life insurance.
    • COBRA insurance premiums for a family of 4 can cost as much as $1900 per month
    • No job => no life insurance => no protection for family

What did I learn from these cycles?

The lessons I learnt can be broadly classified into the following points:

  • When you see excesses in the market, then it is a forewarning of an upcoming recession.
  • If your only source of income is shaky, then it is hard to take risks and benefit from the recession/bust cycle.
  • Big items (houses and cars) should always be purchased in a recession or bust period.¬†A mistake make in either of the two can take years and years to recover from…especially the house.
  • Make yourself very valuable to your company….but at the same time, be prepared to interview for a job at any time

My plan for the next recession

An often heard sating is: Attack is the best form of defense. For the next recession, I plan to attack it with a goal to benefit from the recession, rather than take it lying down. Based on the lessons learnt from past recession cycles (previous section), here is the action plan I have implemented since April of last year.

  • Lesson:¬†When you see excesses in the market, then it is a forewarning of an upcoming recession.
    • Action plan:
      • Watch for excesses in the market
    • Results:
      • I am already seeing the excesses in the housing market and luxury items.
      • Now, I am sure we are entering the first stage of a bust cycle.
  • Lesson: If your only source of income is shaky, then it is hard to benefit from the recession/bust cycle.
    • Action plan:
      • Create an emergency fund.
      • Develop passive income streams and take out the reliance on income from work
      • Remove reliance on life insurance from the place I work.
    • Results:
      • Starting last year, I have designed and implemented a Passive Income Plan
        • On average, it will pay me roughly $500 per month.
        • Of course, this is not enough to replace my income. But, it does take care of food expenses for the family.
      • I have a 12 month Emergency Fund to take care of any temporary loss of income
        • When the income source is shaky, it is hard to take a risk like buying a house.
        • But, if you can survive for a year without a source of income, the confidence to take a risk is very high.
        • Hence the one year emergency fund.
      • I bought¬†Life Insurance coverage to protect my family.
        • Until last year, my life insurance was provided through my work.
        • But now, life insurance is independent of my work…so, even in a loss of income scenario, my family is protected.
  • Lesson: Big items (houses and cars) should always be purchased in a recession or bust period.
    • Action Plan:
      • Have patience to wait for the next recession to buy
      • Create a good down payment fund that is big enough to reduce the monthly payments
      • Learn how to evaluate a house
    • Results
      • The¬†highest amount of pressure to buy a new car, a new house, etc comes from peer pressure. I can take it, but my family has a hard time dealing with it. I have managed to convince them to stick with my plan until now…they have sacrificed a lot over the last couple of years. Now,¬†I have to deliver on the house at least in the next recession.
      • I have reduced my investments a bit to start accumulating $300 more per month into my home down payment fund. When the recession strikes, I will be ready with my home down payment.
      • I am learning how to evaluate a house for purchase by doing the following:
        • Watch home inspection videos on you tube
        • Watch how pricing is done by reading articles on the net and videos as well.
        • Watch how to not get fooled by real estate agents.
          • A staged house sends warning bells ringing in my ears now….
          • For example, I found a common trick of using undersized furniture (bed, chairs, etc) to make the room look bigger.
          • Damn…these real estate agents are good huh ūüôā
  • Lesson: Make yourself very valuable to your company….but at the same time, be prepared to interview for a job at any time
    • Action Plan
      • Be rated near the top 20% in your company
      • Constant Preparation to make yourself ready to take a job interview on any day.
    • Results:
      • I have been working very hard to produce more things at work…but it has been slow digging.¬†Likewise for my interview preparation.
      • But, now that I have plans in execution for all the other lessons, I will concentrate on this action plan for the rest of this year.

If you have read this far, then you really are a patient soul. Hope this info was useful in some way. Any tips you can share, please do leave a note in the comments section.

Emergency Fund

Why an Emergency Fund?

There are many events in life that cannot be planned for. Let us consider some examples:

  • My close friend used to work for a company that closed down without a hint as to this event happening. This happened when the market was in the dumps…but he was able to ride through it because he had some money stashed up. It was not that he planned to have an emergency was just that he was not financially aware on what to do with that money.
  • My colleague at work had mom continuing to stay in another (home) country. Mom was suddenly diagnosed with a fast acting cancer. My colleague dropped everything and left to take care of mom. Mom lived for another 6 months, but she got to spend the last 6 months with my colleague and died in peace. If my colleague did not have an emergency fund, my colleague could not have afforded those 6 months without pay…6 months that gave my colleague peace for the rest of life.
  • One of my other friends lost a job unexpectedly. His company was doing okay, but they canned his entire product line. He was given two weeks to search for a job inside the company, but it was a time of job freezes every where and he could not get any. Since he had two kids, the COBRA insurance payment for the entire family turned out to cost almost 1900+ dollars! This was a total surprise to him as well as me. Did I say that rent is expensive where I stay? His total monthly expense was almost $5000 per month. He was out of a job for almost 6 months and that is 30 grand right there.

So, for reasons like the above, I wanted to have an emergency fund that will at least give me and my family some months without pay in the event of any emergency. This is especially important since we do not have any relatives or friends that can support us financially.

Size of the Emergency Fund

Having decided to build an emergency fund, the question that arises next is…how much?

  • From seeing my family’s expenses and from seeing what my friends had gone through, I think a minimum of $5000 pm is an absolute necessity.
  • A year’s worth of expenses is what is recommended everywhere.I have nobody I can rely on to host me and my family. I am it.
  • I have a pre-existing health condition for which insurance would be almost impossible to get. So, I added $1000 in addition to account for a high cost insurance.

Considering all that, I decided to have 12 months of expenses for my emergency fund i.e. $72000.

Where to keep the Emergency Money?

Having $72000 in a Bank of America account was earning brutally low interest rate. Based on a tip from a wise soul, I came across Smarty Pig, a FDIC insured online bank that was providing 1% interest for the money. So, I decided to move the emergency fund into a Smarty Pig savings bank account.

Status of this Goal