5 Mistakes People Make in a Recession and How to Avoid Them

There’s no getting around it – recessions are stressful. The 2020 COVID-19 pandemic is just the most recent reminder. Recessions bring volatility, uncertainty, anxiety and the urge to act – do something, anything, to make sure I’m safe. This is often where people make mistakes. Here are a few common ones we see and how to avoid them so you’re ready the next time around.

Mistake 1 – Panic

When the market drops and negative headlines flood your newsfeed, it’s easy to panic! It’s also easy to forget that recessions are part of our economy’s rhythm, occurring every 4-5 years on average. For more, read Recessions – How Bad and How Long Are They?.

Instead, we should expect recessions, not be shocked by them. But just because they’re common, don’t expect them to be stress-free! Fear is a natural response to uncertainty, no matter how well prepared you are. Rather than succumbing to these feelings, expect them! You’re not alone in recession-induced anxiety, but it doesn’t have to dictate your actions.

Mistake 2 – Invading the nest egg

It’s tempting to withdraw from accounts like IRAs and 401(k)s to build reserves or maintain expenses. But this comes at a high cost. First, you’ll pay income taxes on pre-tax retirement accounts and an additional 10% penalty if you’re under 59.5 years old. Second, these are usually withdrawals you can’t replace, costing years of future tax-deferred or tax-free growth.

Instead, look ahead of time at when you can access each strategy and what taxes and penalties you would incur. As you invest, this helps decide how much should go to retirement accounts versus other more flexible investment strategies.

Mistake 3 – Continuing unaware spending

Many continue spending as though there’s no problem. This leaves them at a loss, not knowing how much the belt can be tightened if needed and how much reserve to build.

Instead, try this simple spending awareness exercise! While you don’t need to nickel and dime your expenses, a general awareness of your monthly spending can help. Using the last three months of bank and credit card statements, and perhaps a glass of your favorite beverage, group your expenses into the following categories:

• Fixed – these are necessary, come every month, and don’t change, like your mortgage.
• Variable – these are necessary, come every month, but can change quite a bit, like groceries.
• Fun – everything else!

Once complete, you’ll have a good idea of your household’s minimum monthly need and what you could pull back if needed.

Mistake 4 – Making short-term decisions with long-term money

Recessions almost always come with stock market swings, causing many investors to question if they should sell everything and wait out the volatility. But, in most cases, this would be a mistake. As we cover in Time in the Market is Better than Timing the Market, the best and worst days aren’t far apart, which makes these short-term changes difficult, if not impossible, to time. From 2000 to 2019, 24 of the 25 worst days were within one month of the 25 best days.

Instead, if your investment declines are in line with what’s happening in the overall market and you have a reasonable amount of time before you need the funds, consider Staying the Course.

Mistake 5 – Going it alone

Many who feel anxious can “go down the rabbit hole” of poor decision making in isolation. It’s easy to hit that sell button at midnight after a few isolated hours of reading negative headlines and focusing on short term losses.

Instead, reach out to your advising team or other professionals who can talk through these decisions with you. These are among the most important times to have a team to rely on for advice. You’re never alone in recession-related fears. But a good team has likely heard many of your questions before and can talk through your thoughts, goals, timelines, and strategies to help you make decisions you’ll appreciate years down the road.

The best planning in the world is unlikely to completely take away that sinking feeling when the next recession comes. But, with these five tips, you’ll be on your way to avoiding some of the most common recession mistakes. And once you’ve done it yourself, during the next recession you just might find yourself encouraging others to do the same!