In 1973, Six Flags Over Georgia introduced the Great American Scream Machine, which was, at the time, the largest and fastest roller coaster in the world. Riders were ratcheted to the top of a hill then dropped to the earth below. Thinking that the worst was over, riders soon found out there was much more to come and were dropped once again. Within two more minutes, the ride was over, back where it started. This classic roller coaster is still there, dwarfed by several other taller and faster coasters. In 2008, we began the Great Recession. By December 2008, many thought the worst was over, only to be dropped once more a few months later. Within a few years, we were back where we started. This is where the parallel ends. Riders on the Great American Scream Machine volunteered to be there. Participants in the Great Recession did not.
At the end of 2008, many people thought the worst was over. Lehman had collapsed, interest rates had been lowered three times in three months, the Dow had dropped from a high in October 2007 of 14,000 to 8,000. Swings of 5-10% of value were not uncommon on a daily basis. But there was more to come. By March 9, 2009, the Dow had dropped to 6547, unemployment rose from 5% to 9%, and the economy seemed to come to a complete halt. On a micro level, most of us have a story to tell about how the Great Recession affected us. I recall several crystalized moments, including the day three friends each called me to tell me they had lost their jobs.
While no one knows when the next Great Recession will occur, we do know that it is coming because downturns are part of natural economic cycles. So, is it possible to be prepared? And if so, what can be done to weather the next storm, both economically and emotionally? We have been collecting stories for the last ten years from those who successfully navigated the downturn, and from those who did not, and have noticed several themes that we believe can help one emerge from the next one successfully:
More Debt, More Anxiety
In the downturn, debt fueled anxiety, which fueled desperate behavior. The more debt people were carrying, the more likely the recession was painful. The less debt, the less painful. Small business owners who were committed to having no debt survived the recession and even used cash on hand to buy competitors who were less prepared. Families who had no debt, including their primary residence, were content that, when paired with the news of a job loss, they would survive. Real estate investors with low loan to value ratios were able to cash flow their properties without concern (Len Shannon at Shannon Waltchak has written a great article on commercial property investors in the downturn here). We are fans of having no debt, including one’s primary residence. During the recession, we walked through the decision to pay off homes with many of our clients. Every one of them has told us this was a great decision for them. One can make a mathematical argument that having debt, including in the business and on the primary residence is fiscally prudent, especially in a low interest rate environment. It just happens to almost always create anxiety in bad times. We encourage you to evaluate your debt with recession goggles on. If 2008 happens again, how will debt affect your outcome?
Buy High, Sell Low
For many investors in traditional asset classes (stocks, bonds, etc.), the list of stories of those who sold their stocks, mutual funds, and 401(k)s, during the recession is long. It is almost heartbreaking to hear stories of people who work for a generation to save for retirement, then lose much of it in a financial crisis. Many of these stories we have heard happened because there was no plan. Or there was a plan that was abandoned. Or the plan hinged on esoteric financial strategies that proved ineffective in this situation. While we do not intend to advocate for one investing strategy or another in this space, we believe that it helped investors emerge successfully from the Great Recession when they had a detailed, written plan, often called an investment policy statement (IPS). Those without an IPS did not fare so well. All of our clients have an IPS which is a document that lays out exactly what the investor will do in good times, and bad. Do you have an investment policy statement? If you follow it, how will you fare in the next downturn? Have you decided what to do, while you are not in crisis?
Speak The Unspoken Truth
With 2009 so far behind us, I have heard many stories of those who appeared to be fine on the outside, but who were crumbling on the inside because of the stress and anxiety that came from attempting to keep a good face while making financial decisions alone. We believe those who had an outside party as a sounding board, or some type of accountability, were more likely to emerge successfully from the Great Recession. We have also heard many stories of those who were not faring so well, but who had an ally for accountability, transparency, or even commiseration. We believe that those who did not go through the valley alone emerged better than those who did. For those who were transparent with their families about their money woes, there was more likelihood to be met with grace. For business owners who had to make tough decisions around layoffs, pay and benefit decreases, or other cost reductions, the process was easier and more supported when employees had a full or partial view of financial results so everyone felt they were participating in a solution. This is difficult to do during boom times but sometimes critical in lean times. How transparent are you with your family or other stakeholders? Do you have an outside influence who is helping you make financial decisions? How will you fare next time?
Jack Be Nimble
The 2009 crisis hit real estate especially hard. For many who owned real estate, sometimes even just a primary residence, illiquid assets became a ball and chain. Even for those with no debt, it was nearly impossible to sell houses, second homes, land, or commercial property, and the more people owned hard assets, the more chained they were to their situation. For business owners, those with little to no fixed costs had flexibility when those who had more were unable to move quickly to survive. And for individuals, families, businesses and real estate investors, in a recession, cash is king. In an expansion, sometimes cash seems to be a waste of resources. As for cash, those who had a lot on hand during 2009 were able to buy almost any asset class at pennies on the dollar, creating significant wealth for them over time. How nimble will you be next time? How much flexibility do you have in how much real estate you own or how much of your costs are variable? And how much cash do you have on hand so that you are prepared to buy at a discount in the next downturn?
Defense Wins Championships
When it all comes down, sometimes things just don’t go your way. As a safety net, we have observed that those who had a thoughtful plan for asset protection emerged better than those who did not. For families who were passing wealth to the next generation, a creative legal structure prevented many unfortunate outcomes. In many families, protecting the next generation from their own poor decision making during the downturn, proved to be an important tool in protecting family assets. This is a complicated matter for many which we will not address in detail here. It has been our view that families who had discussed many eventualities were able to protect what they had from being taken by creditors or others. Is your asset protection structure adequate to protect you, your family, and your business in the very worst of times?
What Does Not Kill You Will Only Make You Stronger
We believe that investors who had been through a significant downturn before, and survived to tell about it, fared better in 2009 than others. More so, those who had a fresh recollection of their last experience fared well. The problem now is that it has been such a long time since a significant bump in the economy, that some may be forgetting the lessons of the past. From time to time we notice those who are assuming only good things going forward. Increasing debt, increasing purchases of expensive real estate, purchases of businesses at very high multiples, increasing fixed costs, buying into inflated asset classes, and decreasing cash all may decrease the probability of navigating the next downturn with confidence.
Let’s assume that we are on the first incline of the Great American Scream Machine. If we were to have this conversation three years from now, what would you wish then, that you would have done now to prepare?