The photo is of Socrates “If you want to be wrong, follow the masses”. With consumer confidence at an all time high and the “Trump Economy” in full effect with tax breaks, it appears that everyone is ready for another bull run. In this case, it is much more likely that we see a recession. Why? Well consumer confidence is much more tied to recessions. If everyone is up beat the party is usually set to end. So we’re going to to outline our basic items to help make your life more recession proof.
#1 Cut Recurring Costs: This is probably the biggest one. If you can take your recurring costs which are the largest drains on your bank account you’ll be a lot better off long-term. One of the most obvious items is housing. When people try to buy homes they typically get the “biggest they can afford”. Naturally, this leads to serious issues. Instead, we would recommend buying the smallest property that fits your needs (unless you’re rich then you can always do whatever you like). A good example is doing the rent vs. own calculation. As soon as you can reduce your monthly expenses by purchasing you should jump at the opportunity. Housing and Taxes are typically the biggest drains on your monthly cash flow. A recession proof life has minimal monthly cash outlays to housing and taxes simply cannot be avoided. So take a strong look at this line item first and see if you can keep it as a low percentage of monthly income. Somewhere around 10% of income should be spent on total housing costs.
The second group of recurring costs are all of the membership items you have. The good news is that all of these items can be switched off if things get ugly. Your high-end gym can be downgraded (hurting your social life) but the payments stop immediately along with any other memberships you have from a country club to as cheap as a Netflix or cable subscription. Keeping all of these items as low as possible in the first place is a good start. Remember, if it gets ugly over the next couple of years you can immediately delete the recurring cost.
#2 Have a Bigger Cash Balance: If consumer confidence is sky high, this is probably the best time to start building up a basic cash balance. It should go up in a big way if consumer confidence is high because it is a reverse indicator. Feel free to click here and look at the max chart for this dynamic. It doesn’t help that interest rates are going up as well! The good news is that if you build up that cash balance the returns on your boring old safety net will no longer read “1%”.
More important than the actual cash balance is the ability to remain above water. This means you’re not dipping into investments. You never want to be forced to sell anything. This is an important component since we’re not saying to “never sell”. Everyone is free to have their own strategy. The one item we are saying is that being *forced* to sell is an all but guaranteed disaster. Take a hard look at all of your cash balances and decide if it is going to be enough to sustain a 50% drop in all of your investments. This does not just mean a 50% drop in stocks, bonds, crypto and real estate, it means a 50% drop in all of your passive income as well. When tough times come in a 50% drop is possible and when that occurs cash flows can also decrease by 50%.
#3 Create a Recession Proof Income: Recession proof income requires doing something that is needed when people have no money. In an absolute worst case scenario, you’ll want to find a way to be cash flow positive assuming your income streams dry up. This is exactly why most millionaires have 5+ streams of income. Recession proof income includes: 1) staple goods, 2) alcohol and other depressives and 3) time for money exchanges. Ironically, if absolutely everything is going wrong you should have at least one skill where you can exchange your time for money. Notice, this is dead last for all of the ideas but many people are not financially independent. If someone falls into this category we would suggest that they look at their skills and make sure they have a time for money exchange lined up for the next downturn.
#4 No Debt: Many people go and get MBAs and other degrees when the job market is dried up. We wouldn’t do this. Going into debt and praying things are better in two years is simply a gamble. Debt in general isn’t good unless it is making you money (mortgages and leverage as explained in triangle investing). It is better to find a way to live off the bare minimum than go into debt since you’ll be chasing interest payments for items you consumed in the past. Any sort of debt entering a high consumer confidence time frame isn’t good. Clear it all out and give yourself more buffer in case things get ugly. Mathematically, this means the interest payments you’re making should be 50% the amount the asset produces. So if you have a monthly payment of $500 the asset should be generating $1,000 a month (you can weather a 50% cut to the income line and still not worry about missing payments).
#5 Cash Flow Out Three Years: Here is a good back of the envelope calculation. Take your bare bones living expenses and add 25% to them. Your bare bones living expenses do not include partying and fun, it is simply waking up eating, sleeping, going to a cheap gym and basic internet/cell phone use. Add 25% to this and that is your monthly number. Once you have this monthly number figure out if you can live for three years straight.
While obvious, we mean three years straight assuming your income get cut in by 50%. To avoid any confusion here is a basic example: Say your barebones need is $4K. This would then mean $5K per month. If you can get through $180K worth of expenses without selling anything you are set. If this person makes $7K per month, it means he has a $1.5K/month hole to fill for three years. $54K in cash + an assumed 50% drop in income… Would just be enough. Unsurprisingly, most people do not save any where near 50% of their income so this math hurts quite a bit. It also assumes we’re entering into a pro-longed bear market of three years (most downturns only last 1-2 years).
#6 Do a Dry Run: If the above 5 items already have you thinking, we suggest doing a dry run. Since nothing has changed, you can simply do a dry run by taking all your expenses to a minimum. Use a spending tracker like Personal Capital and see what your monthly spend looks like in a downside case. We would do this in a very structured way. At the end of the month (say February 28), pay off all of your credit cards and every single payment you have. Everything should read as a “$0” when you click start.
Starting March 1 for example, you then test run your basic living expenses. It’s a fun game to play once every few years (particularly when consumer confidence is high) so you can see what it would be like to decrease your living standard to the bare minimum. After this dry run you’ll have the exact number from bullet #2. To be extra conservative you can assume you do not drop any monthly memberships so it reflects the bare minimum number for your current life.
#7 Have an Emergency “Out”: Always have a Plan “B”. This means a way to absolutely eradicate all costs from your life. If you’ve travelled for an extended period of time since you earn your money online, there are at least a few places where you enjoy living. This is typically cheaper! Surprise, surprise as to why your status is higher. Now that you’ve got this place in mind, see how much money you’d need to live in this location. Our guess is that the number will come in 50-60% below your current living expenses. This is the “world is ending” location that you can retreat to. In these situations, a good move is to have a way to bring cash into the country (or have it there ready for the exit).
The probability of pulling this off (or needing to pull it off) is probably under 0.00001% for most readers of this blog. But. It sure is fun to have in the back of your mind. There is a lot of truth in saying “screw it and moving to Thailand”. While said as a joke, if you’re single, this is definitely something you can do in an absolute worst case scenario. In this environment, you’re assuming that your income will no longer be higher by living in the United States and all your income will be earned online. We all know you won’t be working a “real” job or career out in a completely different developing country.
#8 Adjust Your Living Structure: If you do all of the steps above and realize the math isn’t looking to good, decide if there is any way to adjust your portfolio, pay off an asset or simply live cheaply for a few months. When things are going right, the cash flow does not seem to matter and you’re looking at a graph that is up and to the right so all of the small expenses just seem to flow out. Assuming you’re close and can survive two years based on all of the above, go ahead and get that to three given current sentiments. When everyone is saying things are good, that’s not a good sign since you should do the opposite.
The first step is to look at all your investments: 1) which ones are well into the green? If it’s well in to the green by a large margin, consider trimming this slightly to get your number to three years, 2) if you don’t want to touch this, calculate how many months you would have to live with bare bones minimum expenses to get there (ideally no more than 6 months) and do that and 3) if both of these options are unappealing, we’d look for a new stream of income to begin making up the hole between the two year and three year gap. There is just no reason at all to gather millions of dollars only to be forced to sell it at a low point because the cash balance wasn’t quite high enough. It’s a perfectly avoidable scenario and we’d adjust now when confidence is high versus later when confidence is low.
#9 Invest More in Recession Proof Stocks: This helps you offset the portfolio declines. If you don’t have a consumer staples income stream… just buy those stocks during high consumer confidence scenarios. They would include things like McDonalds, Walmart, AT&T and Procter and Gamble… For those that bought Triangle Investing, now you know why we own them in our active portfolio! For this exact reason. These stocks are so boring and standard that they typically pay out increasing dividends in a down turn. Everyone needs to use the internet and have phone service. Everyone eats cheap food. And. Everyone needs basic health care products like toothpaste. No it isn’t exciting. No it won’t impress anyone at a bar or night club. But. Yes it will save your cash flow in a downdraft.
#10 Avoid Junk Bonds: While they are fantastic during bull runs (last 8 years or so), they have high default rates during downturns. Over the past 8 years many high yield bonds of 7-10% actually performed perfectly fine. Capital was easy to raise and we saw minimal down drafts in the economy since 2010. The reverse is true going forward. The default probability naturally goes up when cash is sparse. Assume that the returns will be negative and avoid all high yield bonds over the next few years.
Bonus – Have a Tough Conversation Before it is Too Late: If you have a significant other, it is best to have an honest conversation about your current spending patterns. This front runs the down-side and helps you combat the future. We are guessing 90% of our readers (including us) are not in this situation. That said, we do have some readers with signficant others, spouses etc. We’d go through this conversation now before it has to be done in a hectic time frame. Do the math. If you’re fine, great. If you’re off by a few months… fix the issue now so when the weather turns sour you’ll be ready!
To wrap all this up. The only reason we are writing this now is because of the current comments about the economy and overall bullish tone. We could see another 5 years of upside (90% of years are up anyway) so who knows. That said, when people are bullish, bad and aggressive decisions are made (yes, sadly many people bought crypto currencies on credit cards in December/January). We’d stay the course and make sure all financial numbers are in order. If so, no need to worry and enjoy the week!
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