Here's How Investors Should Prepare for the Next Recession

Some leading economists have predicted that the next recession will be particularly bad. Despite headlines such as these, the truth of the matter is that nobody can tell you when a recession will occur, how bad it will be, or what the root cause will be. Having said that, there are steps you can take to set yourself up to get through the next recession with as little damage as possible.

A full transcript follows the video.

This video was recorded on Oct. 1, 2018.

Jason Moser: OK, Matt, let's talk about recessions. It seems like we just came out of one. But that really was actually a long time ago now. It was just a really bad one, wasn't it? [laughs] We have a lot that we learned from that.

I was reading an article, and I had an interview with KABC Radio last week. We were talking about this article in The New York Post which posited that the next recession we hit is going to be worse than the Great Depression, and there's basically nothing we can do about it. Now, the reasons are myriad. Economists, as you and I know, love to prognosticate. But I found this to be a very interesting discussion. The first thing that came to my mind when we had this interview was, "Well, we're going to have another recession. It's not a matter of if, it's a matter of when." Does the size really matter? I don't know. What do you think?

Matt Frankel: Continuing our discussion of forecast, remember that headlines like that, projections like that, are forecasts. Take them with a big grain of salt. No one can tell you how bad a recession is going to be. Two other things: no one can tell you when it's going to come. Could a recession happen later this year? Sure. Could a recession come two years from now, when the market's gone up another 20%? Of course. Don't stop investing in the meantime because you think a recession is going to come.

Second thing, no one can tell you what's going to cause it. If you had told somebody 15 years ago that mortgage derivatives were going to be responsible for the near collapse of the financial markets, no one would have believed you. There are a bunch of things that kind of look a little bubbly right now. A lot of the lending markets, auto lending in particular, the subprime auto market looks really dangerous right now. They're pretty much doing the same thing with subprime auto loans that they did with mortgage loans before the Great Recession.

Moser: Subprime auto loans? Good lord, man! That just sounds like the danger zone. [laughs]

Frankel: One out of every four auto loans made right now is made to somebody who's considered subprime or deep subprime. And they're packaging these and selling them as quality products, like they were doing with mortgages. There's other things, too. I don't have to tell anybody that student debt is becoming a real bubble. Cryptocurrencies, there's a lot of speculation that, if that market bursts, it could really kill the economy because the millennial generation is disproportionately invested in those. That could be a big mess. And, tech stocks that seem to go nowhere but up, some of them are starting to look a little bit frothy.

The point is, no one can tell you what's going to cause the next big market drop. Don't stop investing. Definitely don't sell your positions. But if you're worried that, yes, we've been in the longest bull market ever, it could be a good idea to play a little defense. Maybe keep a little bit more cash on the sidelines than you normally do. That's what I'm doing right now, and what I'm advising people who I advise to do. In my opinion, if you're worried about a recession, stay away from aggressive stocks. I tend to put more of my money in defensive names -- real estate investment trusts, dividend aristocrats, things like that -- if I'm worried that the stock market's a little overvalued. That's served me very well in the past.

Don't stop investing, but there are some good ways you can prepare for it.

Moser: I like all that thinking right there. I think you keyed in on a lot of good points there. Don't panic, obviously. That makes a big difference. We talked about last week a bright right spot for homeowners. Homeowners are a little bit richer this year than they were last year on average. We had mentioned that homeowners' equity had bumped up around 13%. Homeowners, on average, here in the country, are feeling about $16,000 richer.

But that led us into another discussion there. I think you and I both were an agreement there, that equity, don't spend that stuff on frivolous things. Don't tap your home equity and go travel. That's a great defensive position to hold if we ever run into a nasty recession. I mean, obviously, in a recession, housing valuations are going to go down. That'll be something you have to address, as well. But you certainly don't want to be caught in the position of that valuation going down, and then you have a lot of debt outstanding on a second, or, God forbid, even third mortgage.

Frankel: Let's say you own 40% of the equity in your home. If your house price goes down 30%, you still have positive equity. You're not underwater. Whereas if you only have, say, 10% equity on your house, and the market goes down 30%, you're really underwater. You can't afford to move if you want to move, not to mention being able to borrow from the home. It's a really big luxury to have a nice cushion, especially if you're concerned about going into a recession.

Moser: Always be prepared, folks. It's a matter of when, not if.