The following is a guest post from William Cowie @ www.dropdeadmoney.com.
How did the recession of 2008-09 affect your plans to retire by 40? Or any age, for that matter? Did it set you back a bit?
Or did it move your plans forward by a few years? It should have.
(Joe> 84% of our readers are better off today than 4 years ago. That’s actually quite amazing considering how deep the recession was.)
Forward? How can a recession advance anybody’s plans to retire?
Glad you asked.
Understand Recessions Are Inevitable
They’re actually even predictable to some degree.
Take a look at this chart:
Since World War 2, we’ve already had 11 recessions. And if you go back another hundred years, you’ll see the same pattern. Those dates in red show the bottom of each recession. Now look: how far they spaced apart?
Would you agree: another recession is inevitable? It’s only a matter of when. In the past, recessions occurred at intervals of 7-10 years (barring a few that came a little quicker).
It’s almost like summer hurricanes in theCaribbean. We know they’re going to happen. We just don’t know when and where exactly. Fortunately, we’ve developed a good system of hurricane warnings.
A hurricane warning is useful, because while it can’t change the course of the storm, it can predict its path with some accuracy and the warning enables people in its path to board up their houses and evacuate.
So the warning doesn’t take away the storm, but it significantly reduces the damage it causes.
And, as you can see above, we have developed enough knowledge about the economic cycle and its “bad face:” recessions.
The Cycle Has Good Faces, Too
The economic cycle is not just about recessions, just like weather forecasting is not just about hurricanes and tornadoes.
If you look at the chart above, you will see a pattern. From one bottom to the next bottom is one cycle. Although no two cycles look exactly the same, you can clearly see they each have the same pattern.
Here is where this discussion turns from merely interesting to life changing.
Why is that? Because each cycle can be broken down into four distinct phases, much like a year has four seasons.
In fact, with a single exception, each phase of a single economic cycle corresponds closely to its natural season counterpart.
Winter = recession
Spring = early recovery
Summer = “normal” growth
Autumn = harvest
Here’s a diagram showing how these phases flow from one to the other:
Why is this significant? Because what you do in each “season” is sufficiently different that if you do the wrong thing, it can set you back years in your quest to retire early.
So what are these things to do and not to do?
Just as recessions are inevitable, so also is the recovery after recessions. Every recession we’ve had, and we’ve plenty, is followed by a recovery. This is the time a farmer plants. It is the ONLY time a farmer plants. Likewise, in the economy, this is the only time to invest. This is when prices are their lowest. Buy low, sell high? This is buy low time. Prices are never lower than this time.
A farmer CAN plant later in the year, but those plants will not mature and deliver a crop. In the same way you CAN invest when prices start rising, but you’re missing the main benefit.
Spring turns to summer imperceptibly but when it does, planting season is over. Then all a farmer does is work hard and tend the crop: make sure it gets water and the bugs and weeds are kept under control. Likewise in the economy, this is when things heat up and simply maintaining what you have: your job, your business, your investments, absorbs all your attention.
This is the interesting season in the natural, and it’s also the interesting “season” in the economy. This is when the economy begins to overheat and you see inflation and all kinds of shortages and “bubbles.” A bubble is when prices for some item begin to skyrocket past all logical explanations. Think housing bubble 2007 and tech stock bubble 1999. (8 years apart, by the way – do your own math for the future.)
In the natural, a farmer uses this season to cut down everything and sell it. That’s what harvest season is for. It’s what you should do in the economic harvest season as well. This is the “sell high” season in the buy low, sell high advice. Sell everything. If you have a 401k, IRA, or stocks and/or mutual funds outside of retirement funds, this is the time to sell and put the proceeds in a money market fund. No, it won’t go up, but this is the time of the economy you want to heed that other advice of Warren Buffett: don’t lose it. You know the markets are all going to fall. They always do after the bubble season is over.
Remember when we said recessions are inevitable? They’re especially inevitable (if there is such a thing) after bubble season. Here’s a historical fact: every single bubble in history was followed by a recession. Every single one. You can hold out for the last little bit of gain, or you can be cautious and cash out while watching others chase the last musical chair dollar. But when the music stops, you need to have all your assets cashed out, waiting for the inevitable drop.
If you wanted to go extreme, even sell your home. You can buy it back in a few years for a lot less. Or buy a nicer home for the same price. (I said it’s extreme, so don’t yell at me.)
No surprise: winter = recession. Nothing happens on a crop farm in the winter, and nothing happens in the economy in a recession either. Other than prices dropping like crazy, people losing their jobs, homes being foreclosed on, and so forth.
If you’re not prepared, recession can be quite a miserable time. However, if you are prepared it’s like seeing winter come, and taking a plane to Cancun orJamaicafor the winter. Yeah, it’s still winter, but because you’re prepared, winter is nice.
If you did what we said above and sold everything in the harvest season and got out of debt and ended up with cash, this is where you rub your little hands together, because this is what you’ve been waiting for: bargains!
Think back a couple of years — everything was on sale! From cars toCaribbeancruises, everything was 30% off or more.
This is the time to buy a house, whether for yourself or for an investment rental property. But you have to have money, because the banks are so gun shy in times like these, you’ll have to have at least 30% to put down, instead of the usual 20%. If you’re contemplating buying your first house, wait. Wait until this season happens. It always does, and it doesn’t take that long. But the saving is worth the wait.
If you’re into stocks or mutual funds, this is the time to load up again. You almost can’t go wrong. It’s like shooting fish in a barrel — almost every stock is undervalued. Everyone around you will moan and whine like it’s the end of the world, but it isn’t. It’s only the next season. Time to buy, because this season is followed by spring and summer. It always is.
What Did You Do?
Did you invest when prices were high? You won’t be the only one – 25% of all mortgages in August 2012 were underwater, and that’s only because people bought their houses when prices were too high.
If you want to retire by 40, the key is to understand the flow of the economic cycle. I did, but I started too late. Even so, I practiced what I preach and I came out of this last recession in the best financial shape of my life.
So can you. The time to prepare for the next recession is now. Don’t wait until it is too late.
William Cowie was able to retire after the last recession by keying his decisions off the economic cycle. Get his free how-to at www.dropdeadmoney.com