what is a recession and how to benefit from it?

Most of us have heard the word RECESSION recently. But do you actually understand what it means? Is this good or bad for your personal finances? Is there anything you can do to make your personal finances come out in a better shape on the other side of this?

I have to say – I am not a financial advisor. The below will be my views and opinions on the topic. There is no definite answer when it comes to what are the things for you to do in order to avoid feeling the recession in your bank account.

I have recently made some changes to my portfolio that I will share below. All of this is only my personal approach to what to do with my money.

what a recession is?

Recession is an economics term that describes the whole economy slowing down and turning negative for a period of time. This results in GDP of a certain economy to shrink for a while. 

In case you aren’t sure what GDP is – a combined value of goods/services produces by economy. If I was to write a book and you were to open a shop – all the value we generate is what contributes to the GDP of the given economy.

In economics terminology – recession is at least two quarters of a year in a row of economy shrinking. Historically, most recessions have averaged roughly 18 months as of mid 19th century. If we look at second half of 20th century – these been less than 12 months on average.

While this can cause some serious difficulties for you in the short term when it comes to your personal finance, this will pass and we won’t remember the impact of this in next 5 years time (same as not many think of the consequence of 2008 financial crisis right now).

why are there currently recession concerns?

This is a tricky question to answer. Clearly, if we would know what triggers recessions exactly, we would avoid doing these actions…. Would we???

I have previously looked into the reason why we are going through inflation. The reasons for recession are no more different than that really.

Long periods of high inflation bring a lot of uncertainty. What we are currently seeing – cost of energy spiralling out of control. This is not only caused by the previous decisions made by government. I also believe that the war happening in Ukraine is a major contributor to the situation we are finding ourselves in.

All of the above makes people really nervous. This results in people being forced to cut down on their spending as the amount of goods they can afford significantly drops. Not only that, the uncertainty of what tomorrow might look like makes people to spend even less today in order to have some cash available tomorrow in case the unexpected happens. 

The above situation is where having an emergency fund comes of extreme value to an individual!

The above is also true for many businesses. Many small businesses are not sure they can survive the winter with energy prices going through the roof. Bigger businesses are concerned about population spending less. 

The above results in the whole economy slowing down as spending suddenly drops. On top of the above – the cost of borrowing is on the rise (central bank interest rates). And hello! The recession is here.

risk to your portfolio

As the economy shrinks, many businesses will feel the effect of this. This will translate into their P&L statements. This can result in a drop in the value of shares of any business.

The other factor that can impact the stock market negatively – nervousness. As people are getting more concerned about the future they are very likely to sell some of their assets and sit on more cash…. just in case.

It isn’t only the stock market that will have an impact. During recession times there is a high probability of property market prices being impacted as well. So a price of your home is likely to drop in the short term. This doesn’t sound great for sure. On the other hand – if you have some savings and are looking to buy a property, this can be an opportunity for you to do so at a reduced price.

The effect of recession will be seen in many different types of assets and markets. And while the above doesn’t sound great at all – there is some silver lining here (not only for those looking to buy property).

Firstly, you can review your portfolio and move parts of it into more defensive assets. There are some businesses that will do better than others in the recession. They might actually deliver you positive returns during this period. Examples of these types of businesses can be found here.

It is also a great idea to have more cash available for when you spot amazing opportunities to invest into. When markets and asset values are down – that’s the time to make your move. Once the economy recovers, you will see the value of the decisions you made.

what changes have a I done to my portfolio?

I have followed a somewhat similar path to the above. I have started looking more into assets that will generate me extra cash flow. An example of that – dividend paying stocks. Even if the price of these shares will drop in the short term – I should be getting decent dividend yield.

I believe that currently banks are in a prime position to benefit from what is happening. Current valuation of majority of high street banks is very low in my view. This is as a result of COVID impact in the past. The banks have never fully recovered since then in terms of value of their shares.

What banks offer right now – 3-5% dividend yield. This can increase as they are likely to benefit the most from central banks currently increasing the interest rates. If that is the case, not only you are likely looking at an increased dividends over time – the share price will jump as well. You can have a look into some of these banks over here.

I was also looking to buy a rental property some months back. This idea has now been dropped. Instead I put cash into some index funds. I hope these will retain their value and there is potentially some upside before I start looking into the property market. 

If property market is actually going to drop – having more cash in hand is the key for me. This is something I have done as well. I am currently sitting on more cash than I normally would. I don’t want to miss a great opportunity when one pops up in front of me.  

summary

Recession isn’t the brightest of the prospects for sure. Many things can go against you and it is hard to be prepared for all of them.

There is a rule in the world of investments – you buy when everyone sells and sell when everyone is buying. This is something I would be open to if we indeed see a recession in the next couple of months.

Those who have cash to invest will be able to disproportionately benefit from the events likely to happen.

Consider reviewing your current portfolio in favour of slightly more defensive one. Hold a bit more cash as well in case some great opportunities start popping up. Think – how can you generate income in the near term future if asset prices start dropping. Dividends is the answer in my view.