Worldwide, people are dealing with an increase of costs on goods and services, rise in borrowing costs, and general financial strain. The International Monetary Fund is predicting only 2.9% global growth in 2023, which is the weakest growth profile since 2001, aside from the global financial crisis of 2008 and the acute phase of the COVID-19 pandemic. Generation X, those born between 1965 and 1980, are particularly concerned about the state of the economy. According to Annuity, about 60% of Gen X have cut back on spending as a response to changes in the economy, more than any other age group.
Gen Xers are in their earning prime, saddled with higher and higher expenses and gearing up for some of their most expensive phases of their life, including retirement, so now is not an ideal time for an economic turndown. You may be thinking, how can I prepare for a recession? Well, we can’t prevent a recession, but what we can do is provide you with a recession “playbook.” Think of it as your own personal guide to navigating the financial changes that are likely to come this year.
At Arsenal Financial, we want to help address the effects of the recession on your life while striving to optimize the opportunities! In this playbook, we will discuss what inflation is and the impact on interest rates as well as how to plan for inflation, take on volatility, and potentially use bonds to your advantage! ?
Inflation Crash Course
The term inflation often gets thrown around in the financial world without pinning down what it actually is. Inflation is simply the rate of increase in prices over a given period of time. Inflation is either rising, dropping or staying flat; however, the concern becomes the rate of inflation. The higher the inflation rate, the faster prices will rise. A target range for inflation set by the Federal Reserve is between 2-2.5%. The inflation rate for 2023 is predicted to be about 4.8% compared to 9.59% in 2022. So, even though it’s starting to cool, it will still be outside of the target range. The Federal Reserve raises interest rates to combat rising inflation and provide price stability.
How is inflation even measured? Well, in the US, inflation is measured using the percentage of the rise in the Consumer Price Index (CPI), which is reported monthly by the Bureau of Labor Statistics (BLS). A CPI of 110 means that something that once cost $100 now costs $110. That is a percentage change of 10%, which means inflation would be 10%. Because the CPI is an example of the price of an average market basket of consumer goods and services purchased by households, it doesn’t necessarily reflect the exact inflation for all items. It’s used as a rough estimation of how price changes will affect your specific cost of living.
The purchasing power of the dollar continues to shrink, meaning you will always need more money over time to purchase the same item. Think of how a movie ticket used to be $5 and a gallon of gas was barely tipping over $1. However, inflation can be sped up or slowed down by economic factors in addition to action by the Federal Reserve who has a mandate to retain ‘price stability’.
Understanding Current Interest Rates
Interest rates, like inflation, are on the rise. Unfortunately, this negatively impacts those who still need to borrow money, like those taking out student loans, mortgages, and car loans. However, higher interest rates can actually be useful for fixed income investments.
A fixed income investment is a type of investment that pays investors a fixed interest rate or dividend payment until it matures, this typically includes bonds, CD’s, and money market funds. A bond is when you loan the government or companies money and they pay you back with interest. When interest rates are higher, you can lock in a higher rate of return for your bonds.
An effective way to use bonds in a rising interest rate environment to your advantage can be to use bond ladders. A bond ladder is a series of bonds that mature in regular intervals, like every three, six, nine, or 12 months. When that period of time is up, the bonds are reinvested at the higher interest rate. So everytime the bond matures, you could take advantage of a new, higher rate because as the interest rates rise, the yield on your bonds rises as well – earning you more money ?- cha-ching!
How to Plan for Inflation
In 2020, the world economy was rocked by the COVID-19 pandemic. World production came to a screeching halt, which disrupted supply chains and created major shipping delays that was only exacerbated by increased demand and labor shortages. And that’s without accounting for the extreme demand of medical supplies and an acute spike in deaths worldwide. The economy, and structure of society, was weakened as a whole, which significantly weakened the power of the dollar – albeit temporarily.
Of course, we can’t possibly anticipate something like a global pandemic, but we can anticipate change and plan accordingly. Three goods that are most notably impacted by inflation are fuel/energy, cars, and groceries. The Bureau of Labor Statistics estimated that in 2022, energy prices are up 17.6%, new vehicle prices have increased 8.4%, and food prices have increased by 10.9%. How can you prepare for inflation and manage its effects? Let’s break it down by each group:
Gasoline, Heating, Energy, and Other Utilities
Since our society continues to rely on fossil fuels, it is impossible to avoid the effects of the rise in gas and energy prices. This is especially true for those who are not working remotely. Some ways to manage the price of gas is to take public transportation, carpool to work, or our personal favorite- ride your bike! Additionally, if it’s possible, ask your manager if it is possible to work from home on either some or all of the days of the week.
Some energy and utility companies offer financial assistance so it is worth calling your energy company to inquire about such programs or directenergy.com – a natural gas and electric provider that offers competitive packages. The point is, it’s much better for you to be proactive rather than fall behind on bills- owing the energy company will increase your debt rather than lower it, and falling too far behind can even affect your credit score.
Federal and state governments also offer support for families with their energy bills. Both The Low Income Home Energy Assistance Program and the Weatherization Assistance Program both work to assist families with energy bills and prevent families from being left in the cold (literally and metaphorically). If you do not qualify for these programs, you can look for programs in your state that can offer the same support.
Cars and Car-Related Services
Both cars and their repairs are becoming more expensive. Fewer cars are being made and the demand continues to grow, which drives up the price. The demand for cars has been sustained largely by low interest rates, shifts in spending during lockdowns, and stimulus payments.
If you are in the market for a new car, and your current car is working fine, it might be worth it to wait it out for at least a few more months. If you have repairs on your current car that can be safely put off for a few months, take that time to save up a bit before you take your car to the shop. Remember, it costs more to finance and borrow money to pay for these vehicles.
If you absolutely have to get a new car, consider your used options. In 2022, used car prices only went up 2.0% while new cars went up 8.4%. Since Gen Xers are gearing up for retirement, you don’t want to give yourself a large monthly payment for the next several years.
Overall, the balance of supply and demand of cars are likely to balance out soon, so it might be best to ride it out for as long as you can.?
Food and Groceries
Because everybody eats, that’s one of the most noticeable changes when it comes to inflation. According to the US Department of Agriculture, Americans spent around 10% of their disposable income on food, so any increase in price while making a significant impact on your spending abilities. Gen Xers likely have a whole family to feed rather than just themselves, so the impact is multiplied.
However, the impact can be managed with strategic shopping. Not all food items are affected to the same degree. For example, meat and eggs have increased more than fruits and vegetables. Additionally, fresh ingredients are generally cheaper than pre-made food. Try to plan meals for the week that incorporate foods whose prices are not spiking.
If you’re not sure where to start, you can use Mint’s grocery calculator to estimate your budget. If you are still in need of additional assistance, food stamps have recently increased. You can check your eligibility through this state directory.
Restaurants are also affected by inflating prices of food, which makes eating out more expensive. Limit your dinners out and make sure to stick to your budget (and as always, account for tip!).
Take on volatility
The market is always going to go up and down, but this should not intimidate long-term investors. In fact, Gen Xers who have been investing for decades may embrace volatility rather than fear it, as you can use it to your advantage. Being flexible in a dynamic market can help you go with the financial flow.
There are a few common mistakes that are made by investors who are threatened by the volatility of the stock market. Inexperienced investors believe they can predict an economic downturn and subsequently make a profit from it. However, according to Morgan Stanley, “individual investors who radically reposition out of stocks in an attempt to catch the tip of a market top reliably miss out on gains more than they prevent losses, and generate excessive transactions and tax costs along the way.” This means that trying to pull a fast one on the stock market will likely cost you money rather than earn you money. Remember the idiom- it’s time IN the market, not market timing. ?
You probably have heard the phrase “buy low, sell high,” right? That’s the ideal scenario for stocks. But, this phrase does not account for the patience that is necessary for this advice to work. Investors can get impatient with a stock that is on the rise and sell too early or hold it too long and ride it all the way down. This means they are missing out on gains instead of preventing loss. Conversely, an investor who is nervous about prices dropping can sell their stocks without waiting for the price to go back up, thus solidifying the loss.
One way to potentially avoid both of those mistakes is to consider your long-term goals. Both of those scenarios are caused by short-term thinking. Think about what your saving goals are in the long run, not just about what money you can earn now. A financial advisor can help support your decision-making when it comes to your investment portfolio. They can help decide what level of risk to take when investing, and they can help you ride the wave of the stock market to pursue your goals and stay the course when times are tough and decision-making seems counterintuitive.
Consider investing in bonds
In 2020 and 2021, the market was very well-positioned for refinancing debt. A refinance refers to any time a loan and its terms get revisited or revised, either by the same institution or a different one. Refinancing may lower your interest rate or save you money over time, but it may not be the best option in all cases, especially as we are entering a new market in 2023.
Refinancing will likely include closing costs, which is extra money you could be using for other goals. Plus, refinancing starts the clock over on your loan. This means, once again, you could be spending more money in the long run than if you stuck with the original loan, so these should be carefully analyzed. ?
The world has changed a lot since 2021 and now refinancing is less of a weapon at the start of 2023. Although refinancing is likely less attractive now, we now have more tools in our investment tool kit.
Enter bonds or ‘fixed income’
Bonds are corporate or government-issued loans used to raise capital. That means you are technically the lender and the corporation or government is technically the borrower,and will pay you the interest for the loan until it matures and will pay you the interest for the loan until it matures. Oh how the tables can turn.
The key feature of many bonds is that they have a fixed rate. That means no matter what the economy looks like, the interest rate stays exactly the same. Bonds are the “slow and steady wins the race” in the mindset of investing. The stability of bonds can offer Gen Xers additional possibilities as they organize their finances to prepare for retirement. Once again, a financial advisor can help you decide what percentage of your investment should go towards bonds based on your savings goals.
Overall, Generation X is uniquely affected by the current economic climate. Gen Xers are earning more than they ever have and are gearing up to retire. A recession may seem like a wrench being thrown into your plan. However, by planning for the recession, taking on the volatility of the stock market, and understanding the value of bonds, along with consulting with your financial advisor, you can continue your investment journey while riding over the bumps in the road.
Recession Toolkit
- Higher interest rates for a longer period of time – This is a paradigm shift from the last 10+ years. The last time we saw this was the global financial crisis of 2008 which created opportunities we haven’t seen for 15+ years.
- Volatility is here to stay – What happens in the day to day doesn’t impact our long-term strategies. Ride the waves of volatility and see your investment continue to grow overtime.
- Continue to work towards your financial goals – but be pragmatic and flexible. Check in with your Financial Advisor on what adjustments you may need to make to your plan that can drive toward where you want to go. Remember – when there are barriers on the journey, we don’t necessarily need to throw in the towel, we just re-route.
- Consider diversification – The next pandemic, war, unknown event is around the corner, and we need to be prepared. Diversifying your profile can help you to be ready for almost anything.
- You still have time on your side – if you’re 55, you may be retiring in 10-15 years, but your investment time horizon may be 30+ years. Stay calm and carry on.
Actions You Can Take Today
- Revisit the purpose for each account you own (savings, brokerage, retirement, etc)
- Evaluate your 401k contributions – especially if your employer has a match
- Potentially rebalance – Stock prices have fallen. Investors tend to under-own stocks after a market decline.
- Knock down that high-interest rate (and rising) debt
- Revisit the stock exposure you have for long-term goals, like retirement.
- Re-evaluate concentrated positions in employer stock
- Review your insurance policies with your agent (life, disability, home, auto)
- Take another look at your employer- sponsored benefits.
- Review your estate plan and all beneficiaries on accounts.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice.
If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
All performance referenced is historical and is no guarantee of future results.
To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
When you link to any of the websites mentioned, we make no representation as to the completeness or accuracy of information provided at these web sites.
Any opinions expressed on those websites are those of the speaker/author.
Bonds are subject to market and interest rate risk if sold prior to maturity.
Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.
Diversification does not protect against market risk. Stock investing includes risks, including fluctuating prices and loss of principal.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
