It was widely reported that the raising of the debt ceiling was needed to avoid a US default, a lowering of the nation’s bond rating, and a double dip recession. Unfortunately, despite the debt ceiling being raised enough to cover the Government’s overspending for a couple of years and an avoidance of a default (which was never likely unless the Executive branch chose to not pay the debt interest since revenues are more than enough to cover the interest on outstanding debt), the nation’s interest rate was lowered and it appears that we are heading into a double dip recession. In the least, the market is clearly showing a downward trend. Since the market is normally a leading indicator, it appears that at least investors are expecting a double dip recession. Talk of default in Europe is certainly not helping matters.
With the current economic scenario, investors of all stripes are understandably nervous. While it is fine to be nervous, rushing out and selling all of your investments would not be wise since doing so could lock in a loss, or even worse – result in missing a big upswing should the double dip not materialize. Instead of selling it all, putting the money into gold and burying it in a mason jar in the backyard, here are seven things that one can do to prepare for the double dip:
- Build up and Emergency Fund: Every family should always have at least 3 month’s worth of expenses saved up in a money market fund at all times. This cash will prevent you from needing to go into debt when the air conditioner breaks, the car breaks down, or one of a number of life’s emergencies occur. It will also allow you to continue to pay for food and the mortgage while looking for another job if layoffs occur. Given that the chance of a layoff increases as the economy tanks, building up enough cash to pay for 6 month’s worth of expenses would be a good idea at this time. This will allow time to find the right job.
- Increase your 401k Contribution: The normal instinct when the market falls is to hold off on investing and sell stocks to build up cash. Unfortunately, this is exactly the wrong thing to do. Once the market begins to fall, a lot of the value is lost very quickly, so selling is like locking the barn door after the horses have been stolen. Instead, one should increase investments since the greatest returns usually occur after large market drops. If you hold stocks and sit pat after a fall, waiting for things to look better, you will be even numerically when the market finally comes back but you will have lost a lot of time. If you are investing regularly during the dips, you’ll be ahead when the market recovers. Even in a sideways market those who buy on the dips make money.
- Free Up Cash Flow for Investing: In addition to increasing 401k contributions, increasing investments in mutual funds and stocks through taxable accounts also makes the most sense in downward markets. During 2009, investment returns of 100-300% were made on individual stocks. Being able to take advantage of the dips requires freeing up cash from other uses. Take a look at expenses and find things you can do without – maybe the membership in that wine club, those extra features on you cell phone, or some of the meals out. Cut back to the bone and start investing the savings. This will also make expenses lower should you lose your job and need to live on your emergency fund. The investments you make may also be liquidated as needed.
- Sell Gold Jewelry: Gold has risen to high heights on speculation and worry about the economy. Instead of rushing out and buying gold with the pack, only to be the one left holding the bag when it returns to $500 per ounce for the next 20 years, take this opportunity to raise some cash by selling old unwanted jewelry.
- Buy Term Life Insurance Independent from your Work: One should always have at least ten times one’s yearly earnings in term life insurance unless one has enough money saved in investments to take care of one’s family in the event of a death. This means that there will be enough money to replace your income if needed. With the risk of a layoff, it makes sense to have at least half of this in a privately bought insurance policy. While this may cost a little more than the group policy at work, term insurance is generally cheap – about $20 per month – and having your own policy will prevent the tragedy of a destitute family where the bread-winner was laid off, losing insurance benefits, and then passed away.
- Raise Cash needed if Retiring within Five Years: It is never a good idea to have money invested in stocks that is needed within five years. With the uncertainty in the markets, it makes even more sense to sell stocks and invest in CDs to have a stockpile of cash ready. Because interest rates are likely to rise, CD terms should be limited to a year at most. Investing in CDs may not offer the returns of stocks, but it avoids the risk of not being able to retire due to a dip in the markets.
- Research Quality Stocks: Just as all stocks, good and bad, rise in a bubble, all stocks, good and bad, drop in a down market. Many great companies have lost 20% or more in the last two weeks. Do your research to find the great companies that are out there, see which have been unfairly beaten down with their deserving kin, and pick up shares as the market dips. When the economy comes roaring back and their competitors have gone out of business, you will make truly spectacular returns.
Don’t get caught up in all of the doom and gloom in the news. Realize that down markets present once-in-a-lifetime opportunities to make some serious gains. Also be smart and make sure you have the cash and insurance ready to weather the storm.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.