The new hot item on the internet today is trying to become financially independent. It seems like I see one or two new blogs every day that promise their readers the path to financial independence and there is no shortage of web forums that are doing the same. FIRE is a worthwhile goal, but it’ll never work unless you create a recession proof financial plan as well.
The appeal to reach FIRE is understandable. Those who want it, want to leave their employer at a young age and enjoy the good life while they are young enough and healthy enough to do so. Some dream of, and succeed in, traveling and spending their time on the beach drinking Mai Tais, and for the Lean FIRE crew, concurrently having some successful side gigs that pay the bills and allow for the freedom to pursue fun projects.
The problem is, of course, what happens if things go wrong? Are you really ready for FIRE? For example, what if there is a recession or stock market downturn? What do the FIRE and Lean FIRE have in store for them at that time? What has the FIRE crew done to create a recession proof financial plan and lifestyle?
CREATE A RECESSION PROOF FINANCIAL PLAN
Now, the purpose of today’s post is not to convince you that there is some impending storm just offshore. The reality is, whether today, tomorrow, next week, next year, or one decade from now may bring a great recession (either one like we have seen, or even one bigger than what we’ve previously witnessed) or significant market downturn.
It happens. These downturns occur frequently enough that it’s prudent to prepare for them. By having a financial preparedness plan, you know that you can sleep comfortably at night and enjoy early retirement without worrying about being forced into making emotionally-charged decisions due to the economy.
Having worked in finance for nearly 20 years, I have learned that it’s not the recession or market downturn that necessarily does the damage, it’s the events surrounding the downturn. If we prepare for these events, we can minimize any catastrophic risk to the FIRE portfolio.
Let’s talk about what can go wrong.
RECESSION PROOF YOUR FAMILY
There’s nothing that can damage well laid out plans like the urgent need and care of family members. The result of what occurs after an emergency tends to correlate with the market. Money is one of the biggest issues that divide families and couples, and often leads to divorce.
These financial problems are near impossible to be dealt with in bad times, and the issues are compounded during a market downturn or recession, as companies cut hours, jobs and more. Even layoffs can cause issues for young families who are counting on every penny of their income.
It’s during this period that experts and not-so-experts are posting online, in blogs and in the news, that it’s a great opportunity to boost your portfolio! Stocks are on sale! It’s only temporary! The loss is on paper only!
But yet… it’s not.
It’s a real loss if there’s an emergency, and the only funds available are your investments, as they will never have the chance to recover. It’s not a popular choice in the best of times: lose your savings to save your child, but in good times, your savings would be enough to keep your family safe. In a downturn, your savings may only be worth half of what they were. Are you prepared for that?
Talk Money To Me
Many children, including adult children, don’t turn to their parents to discuss finances. Many families are not comfortable discussing their true financial lives. That’s fine. Offer help in other ways:
- Encourage them to meet with a fee-based financial advisor
- Offer them a book or two that gives sound advice or resonated with you at one time, and share what you did to set goals ahead of your path to FIRE
- Let your adult child know that you are on a path to FIRE and while you have provided for your own financial security they will be on their own
FIRE is a wonderful goal but leaving the workforce too soon doesn’t allow for much financial security, and we all need to take financial responsibility for ourselves. Easier said than done, I realize.
Are your children getting married? Have you discussed a prenuptial agreement? Did you know there’s post-nuptial agreements if they (or you) are already married? If it’s uncomfortable to discuss, tell your partner that the financial advisor recommended having one. It’s also prudent to consider with blended families as well.
Do your adult children have proper estate planning documents in place? Are conservator and guardianship documents in place for your grandchildren? Do they have an attorney (representative) who can make decisions about personal care (health) and property (non-health)? Encourage them to do this. It would make a great gift: the gift of security.
RECESSION PROOF YOUR SIDE GIG
A side gig can be an excellent opportunity for someone on the path to reaching FIRE. Unfortunately, every small business owner or entrepreneur has a target on their back. It doesn’t matter if your blog is just turning a few dollars a month, if your rental property barely turned a profit, or that your small greenhouse is just that: small. Once you leave the labor force for the “good life”, perceptions about you change.
You see this when people win the lottery. All of a sudden, you are deemed to be wealthy, and it opens the door for others to prey on you. The stories are horrid and imaginative: from little Timmy’s wheelchair to the dog that fell down the well. (Facetiously speaking, of course.) Further, you could become the target of frivolous law suits because “you can afford it.”
When unemployment spikes, there tends to be an increase in these frivolous lawsuits and scams. Don’t let yourself be bullied into a corner. Spend a few moments and a few dollars by speaking to your CPAs, your attorneys and your accountants about how to protect your assets. Ensure you have adequate insurance on your home, your automobile, your profession (if applicable), and most of all, in liability.
Find out how to creditor proof your assets. There are a multitude of ways to insure and protect, keep in mind umbrella insurance is not designed to protect you in your side hustle job: it will not cover and protect any issue. (Lyft and Uber drivers, take note) You need to discuss this with an insurance professional to ensure you are adequately insured and advised.
RECESSION PROOF YOUR PORTFOLIO
1952 called and it wants its investment advice back. Most financial planning that’s been done over the last several decades uses variations of Harry Markowitz modern portfolio theory. An academic debate about portfolio design and risk mitigation is well beyond the scope of this guest post.
However, I will touch on the subject briefly; the prevailing wisdom over the last several years has been to purchase a portfolio of various non-correlated assets to minimize risk. The simplest and most famous of such portfolios is probably an S&P 500 and bond blend, the cruel little joke about diversification is that often it drags down returns too much when times are good, and does not provide enough stability and safety when times are bad.
As an example, lets consider a $100,000 portfolio where$50,000 is invested in the S&P, and $50,000 is invested in bonds. Assuming the S&P goes up 10%, how did the bonds do for the portfolio? The bonds may only earn a few percent, meaning you lost out on decent returns on half of the portfolio.
Now let’s consider the S&P 500 falls 25%. The equities would lose $12,500. Will the bonds appreciate enough in value during a market downturn to offset $12,500 of loss: the answer is sadly, no.
It’s time to reconsider bonds in a portfolio. Luckily, the financial services industry has evolved since 1952. We now have financial vehicles that serve as effective replacements to bonds in a portfolio.
Growth and Stability
There are many low-cost fixed indexed annuities, Modified Endowment Contracts (MECs), and variable annuities that provide bond-like stability to a portfolio while having a much greater upside potential then bonds. Whenever I speak about these vehicles, someone is always quick to point out that these vehicles will not get 100% of the market gain and that’s true.
We’re not trying to get 100% of the gains of the market. With an annuity we’re trying to beat the yield on bonds. As a bonds alternative, an asset that can make seven when the market does 10 could still be a viable option to a bond that offers no such upside potential.
Now I’m not going to try and convince you annuities or MECs are the greatest thing ever. A lot of the products offerings are lousy and there’s been some bad practices with some agents. However, an asset category that provides upside potential, downside risk management, and guaranteed income that exceeds what may be possible using the 4% rule is worth considering.
CREATE A RECESSION PROOF FINANCIAL PLAN
Taking a few easy steps can ensure your FIRE survives the storms.
- Prepare you family by getting them on their own path to FIRE and point them in the direction of knowledgeable professionals to ensure they have financial disaster plan.
- Protect your assets and business by getting adequate insurance, and consult with professions about asset protection. Rethink your financial planning.
- Conventional portfolio design was not intended to provide retirement income for someone retiring in their 40’s. Young retires need to more growth that what can be provided by bonds, and annuities may provide a bond alternative.
Are you prepared for the next recession or have you ever been an investor during a recession? Do you have a recession proof financial plan?
Michael Dinich is the founder of Your Money Geek. He often writes about Finance, Taxes, Politics, Renewable Energy and Geek Culture. Providing clients with the confidence and security to enjoy retirement is his life’s mission.