How to prep for a recession

There is recession talk everywhere with tips on what to do. Time to put my hat in the ring 🙂 Following the scouts’ motto of “always be prepared“, how to go about planning? Where to start?

be-prepared-not-just-for-scouts

Figure out your ramen operating expenses (OPEX)

What is the minimum amount of money that you need to survive every month? Figuring this out is key. Here is a simple step by step

  1. Print out your credit card statement and bank statement and categorize your spending into two buckets.
  2. Fixed costs – money that you can’t avoid spending, examples are rent, taxes, basic health insurance, and basic groceries.
  3. Variable costs – anything that is nonessential. Examples: eating out, Starbucks, Netflix, you get the drift.
  4. Total up your fixed costs – this is your ramen opex. You have to cut your fixed costs to the bone – remember you don’t have to live like this today, this is only in case of a recession.

Liquidity aka cash on hand

The best way to survive a recession is to not run out of money during that period. Winning is all about making it to the other side. The longest recession in the USA lasted 65 months with the largest average being ~22 months. Now that you know your ramen opex, make sure you have at least 22 months (in the worse case) available in liquid cash.

Ok Mr. Moneybags, I don’t have that kind of cash. What can I do now?

A few ideas

Are you correctly insured?

If you are relatively young and healthy, switch into a high deductible healthcare plan to save on healthcare insurance premiums. If you own cars think about how much you drive and price out cheaper pay per mile insurance options like metromile. If you have older cars, increase the deductible and rethink collision and damage coverage. Do you need collision coverage on an 8-year-old car?

Any options for homeowners?

Tap into your home equity in new ways

If you are a homeowner some new options make tapping into your home equity super easy. There is a raft of new startups in the equity financing space such as patch homes and unison that allow you to sell a portion of your equity in your home. They pay you a sum upfront and take an equity interest in your home. You don’t make any monthly payments (since its not a loan) and only pay back the money when you sell your home. Effectively these companies want to participate in the upside potential of your home. This is a great way of unlocking equity in your home for cash that can be used to replenish or buildup your liquidity fund. Since this is not a loan – there are no monthly payments to make, so cash doesn’t leave your pocket.

Recast your mortgage

This option is available if you have paid down some principal balance on your mortgage. A mortgage recast stretches your remaining principal back to the original term. For example, if you are 5 years into a 30-year mortgage, when you do a recast your loan goes back to a 30-year term. This effectively reduces your monthly payment as you have a small principal balance that is paid back over the 30-year term. Another way to think about it is that this like a refinance of your loan but with the same interest rate, you are just extending the term. A lower monthly payment now enables you to take the difference and put it towards your liquidity fund. A recast can also be thought of buying optionality for when a recession hits. If you can be disciplined, you should recast whenever you can and still keep paying the original payment monthly – so you avoid paying excess interest. But when a recession hits you have the option to just pay the lower monthly payment and thus have some extra liquidity available.

But what about investments? Can’t I just sell investments when I need the cash in a recession

Yes, you can sell your investments, however, in a recession, you will be selling into a down cycle into lower prices. This is exactly the wrong time to be selling marketable assets. Cash truly king in a recession.

So TLDR

  1. Make a list of expenses
  2. Calculate fixed v/s variable expenses
  3. Calculate Ramen opex
  4. Have liquidity for at-least 24 months of ramen opex

You can’t time recessions, but you can plan. The best time to plan for bad times is when you are in good times!

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