BOSTON – Fear is one of the biggest motivators when it comes to money management, and ordinary investors act on fear all the time. And while a growing number of economists are saying that a recession now looms as a likely event, consumers are practically frantic at the idea.
Every measure of investor pessimism — they may be designed to gauge optimism, but there isn't enough good feeling to register — shows investors are increasingly concerned about the kind of damage there could be to the economy and how those bigger problems will hit home.
"Most times when there is a recession, people don't know it's a recession until it's over," says Daniel Dorval of Dorval & Chorne Financial Advisors in Minneapolis.
"But they're scared of what's happening and worried about what could happen next. ... What they don't realize is that, for most people, a recession will have no lasting impact on their financial goals or their ability to reach them, unless they do something dumb and hurt themselves trying to avoid the recession."
Indeed, one expert after the next says that the right way for most people to deal with the prospect of a recession is to do nothing, to simply ride out what is likely to be a short- to intermediate-term decline.
Yet one consumer after the next wants to feel like they are doing something to be prepared.
With that in mind, here are some steps that advisers agree investors should take if it will ease their nerves about the economy.
1. See if you could live with your portfolio through a short, steep downturn
While financial advisers loathe the idea of hacking up your portfolio to guard against a downturn, they do suggest considering the performance extremes you could face with your current holdings and making sure you can stay true to your strategy if the economy shakes up the market.
"You should be trying to minimize potential regrets," says Charles Foster, of the Solana Beach, Calif., advisory firm Blankinship & Foster. "That may mean rebalancing, trimming some of your winners, but it probably doesn't mean going all to cash or doing anything too wild. ... You want to avoid the regret of not having enough in the market—because it may keep going up while you wait for a recession—and you want to avoid the regret of having too much in any one position if the market goes down."
Rebalancing a portfolio—culling your winners to return your holdings to their target allocations—is a far cry from panic selling. If your portfolio is more than five percentage points off the bull's-eye, experts believe this is a good time to clean it up.
2. Be your own banker
The people who are most likely to get hurt during an economic downturn are the ones who have to rely on financing, particularly if they lose a job and get into emergency-borrowing situations.
While interest rates may soon be falling, that doesn't mean it's the time to be taking on more credit, particularly if your real fear with a downturn is job loss.
Most consumers can't simply play catch-up and set aside three to six months of living expenses into an emergency fund, but setting aside more money, paying down debt and trying to be self-reliant is critical. If you are worried about a recession—and with the possible exceptions of the biggest-ticket items like homes and cars—you may not want to buy things that you can't afford to pay for in cash.
3. Walk through your own 'worst-case scenario'
Consumers love to play what-if games about lottery winnings, jackpots and prizes, but they hate to go through the same mental process for negative events like job loss or health problems.
In the current economy, job loss is a very real prospect, in many cases, for workers who currently believe their job is safe.
No matter how unlikely the prospect, financial advisers say that someone who fears a recession should logically consider job loss as the likely worst outcome from a downturn.
The thinking should not just be what contacts might lead you to the next job—or what career changes you'd like to consider—but rather how your finances would be affected, from whether you could survive a protracted time without a paycheck to whether you have a loan against your 401(k) that would need to be paid back.
If you don't have sufficient money to be your own banker, and the prospect of job loss is remotely possible, some advisers suggest that the nervous consumer line up some available credit, not to tap into, but to have just in case.
4. Keep your eyes on the prize
Investing is a marathon, not a sprint; the idea is to achieve your goal and reach the finish line, not to have the fastest time between miles 10 and 11.
"The idea is not to make yourself recession-proof, it's to be confident that you can weather the storm," says Mark Balasa of Balasa, Dinverno & Foltz in Itasca, Ill. "Most people will be better off focusing on their long-term goals than focusing on what's happening now and trying to react to it. ... It's pretty hard to get to retirement age without having lived through a few recessions, so don't overreact to what you see in the headlines."
Copyright (c) 2007 MarketWatch, Inc.