I’m firmly in the camp that there is a recession coming soon, perhaps sometime within the next three years. From this perspective, there is a good chance that the central banks of the world, especially Canada, will lower interest rates once again. This will punish savers much the same as they have been punished for the past 10 years. These savings refugees will probably have to flee into the stock market again, as GICs once more lose their shine as investment vehicles.
To prepare for this possibility, I have examined the past 10 years to see what might be the best possible strategy to be prepared for the next potentially devastating recession. There are three strategies I have in mind to protect myself from the next recession.
Use GIC ladders
It was a wonderful day when the GIC once again became a viable savings tool. Earlier in 2018, when the rate on the one-year GIC crossed 2%, I started putting money back into the safest form of savings. Approximately 20-40% of your money could go into GIC ladders. This is not a massive return, but it allows you to keep your money protected from inflation while you wait for an opportunity.
In order to capitalize on increasing interest rates and prepare for a potential reversal in rates, I built a one-year monthly GIC ladder with 75% of the available cash. The average rate of the ladder in 2018 worked out to around 2%. Next year should be slightly higher if rates continue to increase. Though 2% still isn’t much of a return historically, it provides your cash with an inflation-matching mechanism, so you retain your purchasing power for the next year.
The second ladder I put in place was a two- to five-year ladder. This is in preparation for a potential drop in interest rates in the event of a recession. If rates drop down to close to zero once again, you will have locked in an average rate of around 3% at the current two- to five-year rate.
When your GICs mature, you will have a choice. If there is a recession accompanied by a reduction in asset prices, you will have cash available to purchase stocks, bonds, or real estate when they are on sale. If the economy is still strong and rates are still rising, you can roll over your GICs into another at a higher rate and continue the ladder.
Buy dividend stocks from high-quality, dividend-growing companies
For the past several months, bond proxies like BCE (TSX:BCE)(NYSE:BCE), Enbridge (TSX:ENB)(NYSE:ENB), and Emera (TSX:EMA) have become cheaper in anticipation of higher rates. As is quite frequently the case with the market, the sell-off appears to have been overdone. Getting into these stocks, each of which has a dividend of greater than 5%, is a bargain at the moment.
If the economy collapses, there will more than likely once again be a flight to safety. If this occurs, these stocks should appreciate in value. If rates continue to rise it will still be a long time before they are yielding higher than 5% on a super-safe investment like a GIC. If nothing happens, well, you are still getting a pretty nice, growing yield, so just sit back and relax.
These companies have also committed to dividend growth over the next few years, and given the rate of dividend increases, this should keep their payouts ahead of interest rates for the time being. Enbridge, for one, has committed to yearly raises of at least 10% for the next few years. Besides, if there is a recession, the central bank has already demonstrated a willingness to drop rates, so your margin will most likely become cheaper while dividends keep rising.
The recession cometh
Using this strategy should help you be in a position of stability to cash in on a potential recession. Keep in mind, this is a strategy to prepare yourself for a recession, so you may miss out on near-term upside, but you will have cash, defensive stocks, and the option to make the best of a bad situation.
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