Economic downturn is almost a guarantee when it comes to investing and the overall economy. But, financial advisors can help protect you from the harsh effects of an economic downturn.
It can occur for a short period of time, or it can last for numerous years, putting financial pressure and strain on the local or global economy. Understanding how you can navigate and mitigate the negative effects of economic downturn needs to be a foundational piece to any investing or wealth building plan, and financial advisors are great resources to use to ensure you are planning properly.
What Is Economic Downturn?
Before diving into various strategies, let’s define what an economic downturn is. Economic downturn is when the overall economy is retracting by macroeconomic factors.
These factors could be; increased unemployment numbers, home values declining, consumer spending falling, lack of public and institutional investing, and the stock market retracting in value. Recent examples of economic downturn include the global financial crisis of 2007 – 2009.
The housing market crashed and the ripple effect was felt everywhere. The stock market retracted in value, unemployment spiked, and investing slowed down.
Additionally, in February and March of 2020, the world’s economy came to a standstill with COVID-19 cases spiking at a rapid rate. International trade was disrupted, the stock market rapidly declined, and unemployment skyrocketed.
Economic downturn, while going through it, is never a good thing. However, an economic downturn presents unique opportunities for investors, and an investor can certainly capitalize on these opportunities to generate wealth.
What Does a Financial Advisor Do?
Financial advisors wear numerous hats, but exactly what does a financial advisor do? A financial advisor will:
- Establish goals with their clients.
- Understand the client’s financial situation.
- Reviews the clients spending habits, and identifies bloat.
- Helps the client manage risk.
- Helps the client identify investments that fit their risk tolerance and investment goals.
Financial advisors are also able to remove the emotional aspect from the investment decisions. It’s not their money that’s being invested, which helps keep their head level throughout the various swings of the economy.
The Benefits of Having a Financial Advisor Through an Economic Downturn
How do you handle an economic downturn is one of the most commonly asked questions when it comes to generating wealth and investing. The reality is, how you handle an economic downturn can have a lasting impact on your long term financial position.
Having a financial advisor in your corner can help you make the most of an economic downturn. Benefits of working with a financial advisor through an economic downturn include:
- Financial advisors can remove the emotion from a collapsing market, and can stay rational.
- They can help you identify your re-entry point.
- Financial advisors can help you create an exit strategy.
- Talking to a professional through uncertain times can reduce your anxiety.
How a Financial Advisor Can Protect You From Economic Downturns
Not only can financial advisors help you through an economic downturn, they can also help protect you from going through an economic downturn yourself. Just because the economy is falling doesn’t always mean your personal financial situation needs to decline too.
Financial advisors will assist you in many areas, but the following areas should be at the core of their strategy:
Proper Budgeting Practices
First and foremost, a financial advisor will help you set proper budgets. Understanding your must have expenses, and your nice to have expenses, will help you navigate various financial conditions.
It’s not uncommon for individuals or families to overspend in specific areas. Financial advisors will review all your spending and identify areas where you may be able to trim back your spending and reallocate that money elsewhere.
Diversification is a great way to mitigate risk. Financial advisors will help you create a proper diversification strategy. You never want to have 100% of your investing capital in a single investment, as if anything went wrong, you would be negatively impacted.
Some of the common areas a financial advisor will invest in to diversify your money include:
- Real estate
- Equity markets
- Precious metals
Taking it a layer further, they’ll ensure you are properly diversified in each investment class. For instance, let’s review the equity markets.
Instead of just investing into one or two stocks, a diversified portfolio may include; growth stocks, dividend paying stocks, blue chip stocks, ETF’s, and mutual funds. Your money will be spread out, so if any one or two stocks lose a great deal of value, your portfolio will not feel that entire effect.
A diversification strategy also includes identifying additional revenue streams. Financial advisors will help you find investments that fit your risk tolerance and produce passive income.
Having an exit strategy is absolutely critical! Understanding exactly when you should sell an investment when things go either bad or good will help keep more cash in your pocket.
For instance, if you purchased a stock at $200, what is your exit point? If the stock starts to decline, when should you sell your shares and wait for the stock to bottom out?
If the stock starts to incline, what is your exit strategy on the way up so you can take profits?
Protecting the downside, and knowing when to take the profit, is something a financial advisor can help guide you through as they take an unbiased view on the underlying asset and overall market conditions.
Knowing when to re-enter a specific investment can help you maximize your profit. For instance, look at ticker SPY.
In March of 2020, SPY reached $228. In the months that followed, SPY climbed to $431. Understanding how to time the market, and realizing when the market bottomed out, can help an investor generate significant returns.
Stocks go up and down, so when stocks decline, it’s an opportunity to buy them at a lower price!
Having enough cash reserves can help you navigate a financially rough period. For instance, if your ‘must have’ expenses are $4,000/month, a financial advisor may advise you to have $12,000 – $24,000 in cash reserves.
Therefore, if anything happens to your income, you can survive without impacting your quality of life for numerous months. Having cash can help you avoid going into debt, which presents its own problems.
Do You Have an Economic Downturn Plan?
Having a plan for an economic downturn will help protect your finances. There are many moving pieces in constructing an economic downturn plan.
One must consider if they have a proper budget, have a diversification strategy, have an exit strategy for their investments, have a re-entering strategy, and if they have enough cash reserves in the bank. Financial advisors will review these important questions and offer unbiased advice and guidance as to what needs to change to better protect you and your money from economic downturn.