Take Advantage of Economic Cycles

This is a guest article by William Cowie. William is committed to helping people let the economy work for them, and writes at Drop Dead Money.

A few days ago, Flexo asked a great question: Are you better off now than before the recession?

To better understand the implications of the question, take a look at the economic cycles in the USA in our lifetime:

The dates on the chart show the bottoms of each recession we’ve had for the past few decades. Look at the intervals: it’s amazing to see how frequently, and how regularly we’ve had recessions: once every 7-10 years, almost like clockwork.

How does it make you feel?

Consider the up phase of the economic cycle. Remember how it was back in, say 2006, the “good” days? Over dinner your significant other says, “Honey, did you hear Suzie next door sold her place for $450,000? That means ours is worth at least that much, cuz ours is bigger!”

Knowing you paid $250,000 a few years ago, how does that make you feel? Rich. And smart. You just made $200K without breaking a sweat! Doesn’t that feel good?

In case you had any doubt, you opened the envelope that came in the mail that day. It’s from your company’s 401k plan administrator. It’s the report with the nice charts and everything. And those charts show you just got richer by another $30,000. Rich and smart.

How did you feel about your future?

The illusion

But the wealth of the good times is an illusion. In the down phase those gains evaporate. Dick, your new neighbor who bought Suzie’s place next door, loses his job and can’t make the payments. The bank forecloses and sells the place at auction for $200,000. That house went from $450,000 to $200,000 in a few years.

You still owe about $190,000 on your house, so you’re not under water (yet), but how do you feel now? Not so rich any more.

And that envelope with the 401k report? The one that came in the mail that you don’t want to open? It confirms your fears: your portfolio just went down by $50,000, even though you’ve actually been putting in money each month.

How do you feel about your future now? Not so smart any more, more like dismayed and discouraged.

The reality

But stop. Did anything really change? You still live in the same house and you still have the same job. Nothing changed, but rather than feeling rich and smart, you feel dismayed and discouraged.

Fundamentally, nothing has changed. Same house, same job, same 401k portfolio. Why do you feel so bad then?

It’s because you expect the future will always be like today.

It won’t. For hundreds of years, the cycle has been relentless. Always up, then down, then up again.

The strategy

Should we then ignore those illusions of wealth contained in our house and investments, be they mutual funds, stocks or rental properties? No, we shouldn’t ignore them. They are the cornerstone of our wealth, and in most cases account for 75% or more of our assets.

And if we manage them well, they are the key to our financial independence, which is probably the goal all of us are pursuing. My wife and I call it our Drop Dead Money: having enough money to tell our bosses (or customers) to drop dead if we wanted to.

Remember the illusion? When Suzie sold her place, your house could have sold for $450,000. And when the same house went into foreclosure because Dick couldn’t make the payments, your house was worth $200,000.

Now, step back and think: If I could sell my house for $450,000 and buy it back for $200,000 wouldn’t that be good? If I could sell my 401k portfolio when it was up $30K and buy it back when it’s down $50K, wouldn’t I own more?

The answer is you can, and it’s the key to how my wife and I got seriously caught up with our drop dead money in the last recession.

It started for us during the dot com boom and bust. My wife worked for a tech company and she saw how people reacted when their company stock went through the roof. Nobody sold their stock, but they bought all kinds of things because they “felt rich.” Not everybody did that, though. Their CFO retired when he sold enough of his stock near the peak. He was old enough and smart enough to know that stock prices do not go up forever. When the bust came, she saw the company shrink all around her. Her department went from 80 people to 3. And that CFO stayed retired, because he… sold high. Other people in the company were not so fortunate. They lost their jobs and the stuff they bought with debt (instead of selling their stock).

When something that big happens so close to home, it’s impossible to ignore. We didn’t have any debt at the time and we rented, so, other than shrinking incomes we emerged from that crash relatively unscathed. But we were determined not to get caught in a downdraught like that when it happened again, because we knew it would.

And so it happened that when this last recession ended, we were able to retire earlier than we had earlier thought possible. We made the economy work for us.

How can you make the economy work for you?

• • Know that it will happen again. Recessions are inevitable and the illusory gains of the good times will disappear. The reason this is important is it helps our minds cope with our feelings.
  • Go with what you know, not what you feel. You’ve also heard it: buy low and sell high. But, here’s the funny thing: when prices are going up all around you, what do you want to do? Not sell, but… buy!

    Why? Because you don’t want to lose out on the good thing that’s happening, right? It’s a powerful psychological attraction that draws us into the speculative frenzy.

    The reverse is also true. Let’s say you’re smart and you sold when prices were high. If you think it’s easy to buy when prices are low, think again.

    I contemplated buying a rental house a couple of years ago when we were drowning in foreclosed houses. Not a single soul I spoke to thought that was a good idea. “House prices are going down. It’s a bad investment!” But, I would counter, isn’t buying low the best investment strategy?

    Yet I always was met with the one statement that takes people out: “but this is different.” No it isn’t. The cycle goes up and it goes down. When it’s up, it’s hard to imagine it going down. When it’s in the toilet, it’s hard to imagine it going back up again.

    But it does. Act from what you know, not what you feel.

  • The biggest bargains are in the recession. This applies to essentials such as houses and investments. It also applies to frivolous things. Wanna take a cruise? Half price off in the recession. Collecting classic cars? That ’63 split window Corvette is 40% cheaper in the recession.

    If there’s anything you are contemplating which requires more than a piddly amount of money, consider waiting till the next recession — you may just get two for the price of one then.

  • You have to prepare in the good times.

     

    Here’s another thing I learned: when times are good, nobody wants to talk about recession. The ultimate taboo, it seems.But here’s the key: in order to afford the bargains recession brings, you need to prepare in the good times. I don’t know about you, but I’ve never ended up with accidental cash. I needed to be very intentional about the money that’s available when the recession rolls around (as it always does).

    So use the good times to get rid of debt and build a war chest. There are few things as fun as walking into a car dealership with cash in hand to buy a new car for less than the blue book of the same one, used. (No, strike that, it’s never fun to hassle with a dealer. What am I talking about?) But you get the picture: make sure you enter the next recession financially armed and dangerous.

Flexo asked a good question in that post I linked to earlier: how are you now financially after the recession? No matter how you came out of this recession, there is another one coming. It’s not a question of if, but when.

And now that you know there will be bargains waiting for you, now is the time to get your ammunition piled up to take maximum advantage.

Photo: Wikimedia Commons