The risk of a global recession is rising. Photo / 123RF
The Reserve Bank has forecast New Zealand will enter a recession from mid-2023, while other countries around the world, including the United States, are painting a similar picture.
So what can you do to protect your finances and investments from the downsides that come with it?
Katrina Shanks, chief executive of Financial Advice New Zealand, says what typically happens in a recession is higher unemployment and people stop spending as much because they have less disposable income.
The official cash rate has already risen to 4.25 per cent and could go as high as 5.25 per cent meaning the cost of debt is rising. Home loan repayments are on the rise and that could also flow into high rents as landlords try to recoup some of the cost.
Shanks says if you are worried about keeping your job and the rising cost of living there are some key steps you can take.
“I think the best thing that you can do - that many people don’t because we are a country that lives pay-to-pay - is make sure you have got that emergency fund,” Shanks says.
“Don’t overspend in the Christmas period. Don’t go into debt to provide for your Christmas, New Year period, trim it back a bit. Live within your means and build up an emergency fund as fast as you possibly can and make it a priority.”
Shanks says when it comes to how much, the general rule of thumb is enough to cover three months of expenses.
“For many families that’s a lot of money - start small and build up is the way to do it because for many people three months is a lot to save and it may take 18 months for a family to get that. But saving now is better than not saving at all. Chip away at it, set up different bank accounts so you have got control of it so you are not spending it. It certainly does give you peace of mind.”
Financial adviser Christine Hay says her first tip to those worried about a possible recession is to plug the leaks.
“Get back to basics - look at your budget, make homemade lunches, cancel subscriptions, walk or bike to work, do free activities in the weekend, take out library books and then try and increase your income if you need to.
“If your budget doesn’t look like it is going to stack up and you can’t cut down any more expenses, then it’s increasing your income by working a Saturday morning or whatever. Sell old items, and put that money straight into debt.”
While it might be tempting to drop some of your insurance, to save money this could be the worst time.
Shanks says you need your insurance the most when you are most at risk.
“And now is the time when people have got more uncertainty. We have just come through a global pandemic. In terms of having trauma, sickness, life insurance - all that stuff is just as important as it ever was.
“If you are in a situation where you are financially unable to sustain the insurances and protections you have got in place it’s not a matter of just cutting them, it’s understanding how you can get your insurances working for you differently with reduced premiums.”
She says there are things you can do to reduce premium costs such as having a longer wait period before they kick in or by reducing the level of cover for the short term to help you through.
“Certainly cutting your protection is not wise.”
Redundancy cover insurance can be an option for those worried about job loss.
But Shanks says it can be an expensive option for people and can be very hard to claim on.
“If you are going to get redundancy cover, get some good advice to make sure you understand how it activates.”
For those in KiwiSaver, keep contributing if you can afford it.
“If you are in a situation where you have the ability to save and invest money, don’t stop. Don’t stop your contributions to KiwiSaver or to your retirement - keep going because markets recover and no one knows when that [will be],” Shanks says.
For those with investments outside of KiwiSaver, diversification is key.
“Diversification is going to be different forms of assets and different forms of asset classes, for example if you develop your own portfolio, do you have cash? Cash is good in a recession. Do you have a portion in property or are you over-exposed in property? And then equities and the share market.”
Shanks says many Kiwis are now investing in managed funds and it’s also important to make sure that exposure is diversified.
“If you have developed and built your own portfolio, look at balancing it through the use of ETFs [exchange-traded funds] now, which are a modern vehicle for diversification, as well as looking at overall portfolio configuration and where your risk sits.
“As we know, in times of recession demand drops. So what shares are likely to be reflective of demand dropping for their product?”
Hay says there are stocks that do well in a recession compared to others.
“We saw this in Covid times. If you go back to 2020, the grocery stores did very well - people still buy toilet paper - and pharmaceuticals. Anything in the healthcare area always does well in a recession.
“So do financials - the banks. Interest rates have gone up, they are earning more. We call those stocks defensive stocks.”
Power and telecommunication companies also fit that bill.
Areas to avoid include anything that might be affected by lower discretionary spending.
“Basically you wouldn’t buy shares in Restaurant Brands, which is takeaways. That could be shopping centres - they will have a downturn. Although people will still do well in The Warehouse because that’s the bottom end of the budget.”
Hay recommends investors hold higher levels of cash in their portfolios during a recession which could also allow them to invest in some bargains.
Despite term deposit rates now rising to over 5 per cent, Hay isn’t a fan of investors switching to them.
“They have only just started to become attractive and I haven’t seen too much conversation around that. But we have been through this cycle before.”
She says term deposit rates only tend to do better than equities for short periods.
“It will really only be for a matter of months. If the investment timeframe is five years or longer, it’s not going to be the place to be.
“No one can time the market. So you never know when to put that cash back into the market perfectly. There are graphs that show there are three days of the year that are the points where the markets just go up and you are never going to get in on those particular three days. And then when it is gone you have missed it.
“People who think they can time the market - it’s like gambling on a horse is what I liken it to. You can do it with play money, but would you do it with your whole wealth?”
Hay says with rising interest rates, some investors are now finding themselves over-exposed to property.
“That has caused some of them to come into strife because their loans are coming off fixed interest rates and now they are having to sell properties at a time when it is not ideal to sell because the property market has dropped.
“Unfortunately they have learned the lesson the hard way of not diversifying. Within all of my portfolios, and I think most financial advisers would be the same, they always have exposure to property but it might not be a direct property.”
Hay says owning shares in property companies means you get exposure to rental income and valuation increases but it’s much more diversified with the investments largely in commercial buildings - offices or shopping centres - rather than residential property.
“They will put all their money into one rental property and that is their investment. It’s not a great strategy. It’s difficult because people’s mindset, particularly Kiwis, is property: ‘Have a property and you will always be fine’.”
Financial adviser Paul Sewell says a good investment portfolio should be constructed for all types of markets.
“Typically we would have a mixture of active and passive managers. With direct securities as well. But it does depend on the size of the portfolio.
“You are putting people together with the skills and different styles that can navigate the cycles. You are relying on the portfolio manager to navigate the cycle.
“If you have done that - typically an investment plan or retirement plan - then there is nothing you need to do to your portfolio. You’ve got to stay the course.”
But he says with the value of certain asset classes dropping, it may pay to rebalance the portfolio.
“If you are in a drawdown phase, we would make sure there is enough cash to be drawn down without having to tap into growth assets. That may mean there is at least 12 months’ cash within the portfolio that can easily be accessed and that you are able to eat into it over time and it doesn’t matter what is happening over the cycle.”
Demand for bonds may well stay strong, but there's a catch.