What does the onset of recession mean to you?
The decline in the economy could be short and shallow, with the turnaround coming as early as mid-1991. But many conditions in the economy differ from those of the past, and all that is really certain is uncertainty. What precautions should you take in personal financial matters?
As a small investor, should you just withdraw and wait for the upturn? Sophisticated investors say that would be a mistake. Rather, they advise, consider all the factors -- negative and positive -- and then take action. To do nothing may actually invite risk.
"It's important that you not translate economic uncertainty into total inaction," says Fritz Yohn, a corporate economist with Aetna Life & Casualty. "Separate your investor side from your consumer side."
On the personal side, it's a good time to reappraise your financial obligations and make adjustments to reduce them. Now is a good time to recalculate your net worth -- your assets minus your liabilities. Look at the assumptions you are making, particularly the value of your assets. The equity in your home, for instance, may not be what you think it is.
If your job is at risk, now is the time to develop strategies to deal with that problem. Cut your spending, avoid taking on additional debt and save as much as you can to tide you over. Make a plan of action for getting new employment.
Most of you will be able to continue long-term savings. If the amounts are small, consider U.S. savings bonds for safety. Or federal securities that you can buy direct from the Federal Reserve Bank and avoid commissions while increasing your yield.
For short-term investments of three years or less, Stuart Becker, a New York tax accountant, points out that Treasury bills offer absolute safety, are extremely liquid and are exempt from state and local taxes.
For long-term investors, the Investment Company Institute reminds you, "One time-tested investment plan that works well, especially when securities prices are turbulent, is dollar-cost averaging. Many experts consider dollar-cost averaging ideally suited for mutual fund investors. An investor who purchases a fund's shares at regular intervals in fixed-dollar amounts is assured that despite market fluctuations, the average cost of his shares will be less than their average price."
Today's recessionary atmosphere, says Aetna's economist, offers a certain amount of predictability, chiefly in the prospect of lower inflation and reduced short-term interest rates. The Federal Reserve Board has been making slight reductions since July. Rates are expected to be driven lower, despite the Fed's stated tendency to favor inflation reduction over expansion. Lower short-term rates already have altered the risk vs. return trade-offs faced by credit market investors.
"Until this summer, it made sense for investors to park their funds in short-term money markets that were more liquid, because there was little difference in yield between short- and long-term rates," Yohn says. "But now the picture is changing."
How? The drop in short-term rates has steepened the so-called yield curve. Investors who are willing to tie up their money for a longer period of time are usually rewarded in the form of more attractive yields.
Conversely, the short-term money market mentality, while offering safety and liquidity, can inhibit investment opportunity in times like this, says Yohn. By remaining passive, individual investors absorb a certain amount of cost in the form of lower interest rates or, as brokers say, lost upside potential.
"We tend to focus on the risk of taking action and making long-term investment decisions, while we tend to be myopic about the cost of not taking action," Yohn observes. "It's easy to overlook the cost of staying liquid."
If this recession is relatively benign and if investors become convinced it may not last long, they can lock in predictable longer-term interest rates.
By focusing on the cyclical patterns such conditions typically present, investors can make their investment decisions within acceptable risk limits, according to Yohn. The continued easing of short-term rates expected from the Fed should help spur not only a bond market rally but eventually a stock market rebound as well.
1989 Los Angeles Times Syndicate
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