It’s ten years ago that the venerable financial firm Lehman Brothers filed for bankruptcy protection, starting off the worst financial crisis the world had seen since the Great Depression. Since then, the U.S. has seen a decade of growth and prosperity. The stock market continues to climb. Unemployment is at a an all-time low, and wages for blue collar workers are finally starting to climb. Poverty is near its all-time low.
These are all good reasons to be extremely happy about the U.S. economy. But because the good times have lasted an entire decade, it’s all too easy to forget one unavoidable truth: At some point, the economy will turn downward again. It might happen suddenly, as it seemed to in 2008, or more gradually. It might start in just one part of the economy (tech in 2000, real estate in 2008) and then spread. It might happen in another couple of months, or another couple of years, but it will happen.
I am, sadly, old enough to have lived through a few recession cycles–while 2008 was certainly the worst of them, it was hardly the only one. According to the National Bureau of Economic Research, there have been eight recessions during my lifetime. Before 2008, the most memorable of them was the 2001 recession, dubbed the “Dot-Com Bust” and prompted in part by the September 11 attacks that destroyed the World Trade Center.
At the time of the 2008 financial crisis, Sequoia Capital called the startups it was funding to a meeting and presented a legendary slide deck that’s worth looking at again today for its analysis of how the downturn came about and its advice about how to weather bad times. A lot of what Sequoia had to say is still very good advice, both for your company and for your personal finances.
Here’s a look at how you should be preparing now for the economic slowdown that will certainly arrive some time:
1. Get out of debt.
Excessive debt, both for companies and individuals, was at the root of both the 2001 and 2008 recessions, and both companies and individuals with too much of it were the ones who suffered the most. So now is a good time to bring your own debt to manageable levels as much as you can. Pay off credit card debt if you have any. Pay down loans if you can. In many ways, it’s smart to have a mortgage, since interest is generally lower than for other debt and is tax-deductible as well. On the other hand, if housing prices drop and you wind up underwater, that mortgage debt can also be a huge problem.
Having said that, it’s also true that credit is easier to get right now than it will be during a financial crisis. So–while it’s better to reduce debt if at all possible–if you absolutely know that you will absolutely need a loan or other financing within the next year or two and can’t avoid it, consider applying for that credit or funding soon.
2. Cut expenses.
In its slide deck, Sequoia advised its founders to “make cuts” and “spend every dollar as if it were your last.” Cash is king all the time, but never more so than during an economic downturn. Douglas Leone, Sequoia’s global managing partner opined at the time that any company without at least a year of cash in the bank “is in trouble.”
Having enough cash on hand to last a year is great advice for any company or any family or individual. If a year isn’t possible, make it nine months or six months or even three months. The point is that now, while your income is probably as secure as it’s ever been, you should be setting some money aside for savings, so that you can draw on it for a time if that income is reduced or gone. So if you have expenses that make saving impossible, look for ways to reduce them as soon as you can.
3. Don’t count on your home or your stock portfolio to always gain value.
Conventional wisdom says that homes gain about 6 percent in value every year, and that a well-balanced investment portfolio appreciates should appreciate at least 3 to 5 percent a year and often much more. While these numbers may be accurate on the macro level, averaging a large number of homes and investments across geographies and over decades, they may not hold true in the short term, especially if there’s a prolonged recession. A friend of mine bought her house in 2007 and watched it immediately lose value when the financial crisis hit. It took many years to return to the price she paid for it.
The 2008 financial crisis would have been less severe, or might not have happened at all, if millions of people hadn’t made the assumption that they could depend on the homes they were buying to gain value forever. They figured that if they got in over their heads, they could always sell and make some kind of profit. When housing prices dropped, many of them defaulted instead.
The real estate market of the last several years, particularly in hot spots where the tech industry has taken root, may seem like they can keep rising in price forever. They can’t. In Seattle, the hottest market in the country for the last couple of years, the seller’s market has started to cool and average housing prices came down $70,000 this summer. In Snohomish County, the next county to the north, I saw a “price reduced” sign on a house for the first time in the four years I’ve lived here.
So don’t count on making quick money in real estate or in the stock market, and avoid situations where you could be forced to sell. Being able to hold a property for the long haul is your best protection in uncertain times.
4. When it happens, don’t panic.
Take a look at this analysis by Bloomberg. It points up one of the saddest facts about the financial crisis–that it amounted to a huge transfer of funds from ordinary people to banks and pension funds. Not because of the bank bailouts–which were paid back with interest–but because banks and pension funds bought, or at least didn’t sell, when the market was at its lowest.
Small investors did, in huge numbers. From November 2007 to February 2009, they pulled a net $152 billion out of the markets. More than half of those sales took place during the six months from September 2008 to February 2009 when the market was at its lowest point. Those investors lost money that they will never recover, while those who faced their fears and hung on to their investments have made back what they lost and much more.
It’s a useful lesson to keep in mind when (not if) the markets tumble again. Just as we know for sure that the economy will turn downwards, we also know it will recover later on. Remember that fact in the darkest days, and be ready to hold on.
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