How to protect your finances from a double dip recession

Whether we get a double dip recession in the UK depends largely on whether lockdown measures continue after Christmas.

The economy can now be expected to shrink in the fourth quarter, but if things open up again at the beginning of the new year, we could see growth returning, albeit from a lower base. That may look overly optimistic right now, but it would mean the UK avoids two consecutive quarters of negative economic growth.

Regardless of whether the UK technically falls into another recession or not, a further lockdown is clearly bad for the economy. The UK stock market has already shifted downwards to reflect weaker forecasts, and that means investors are left looking at much lower valuations than this time last year.

As difficult as it might sound, this is a time to be putting long term savings to work in the market rather than pulling them out. There may be further falls to come, as the pandemic and its trail of economic damage continue to unfold. A disputed US election result could also unsettle global markets considerably.

But it’s impossible to catch the absolute bottom of markets with any precision. Drip feeding money in monthly is therefore a sensible plan of action for long term investors at the moment, even if you have a lump sum to invest. There are conservative funds available for those investors who want some market exposure but wish to dial down the risk.

Savers do need to make sure their other finances are in shape before committing money to the market however. That means paying down credit cards, personal loans and overdrafts, and building up a cash buffer to deal with any emergencies.

The latest data shows that savers have put £88 billion into cash since March of this year. That’s entirely prudent given the economic outlook, but those with high levels of cash holdings should consider whether some might be better off in the market, particularly as cash is yielding next to nothing right now.

As ever it makes sense to wrap investments in an ISA where possible. The Chancellor’s not going to tell us how he’s going to balance the books until he has a better grasp of the full extent of the damage, but dividends and capital gains could be in the firing line.

Five step plan to shore up your finances

1. Deal with debt

If you have spare cash consider using it to pay down any expensive debt you have, such as credit cards or loans. Paying down a credit card that charges 20% is equivalent to investing and getting a 20% return on your money, so it’s an extremely effective way to improve your finances. If you’ve got lots of borrowing in different places, find the debt with the highest interest rate and start paying that off first, before moving to the next highest rate.

If you don’t have the cash to pay down any borrowing, see if you can shift your debt onto a cheaper rate. Banks often offer low rates on balance transfers to encourage you to switch, sometimes reducing rates to 0%. While this is only temporary it does afford you some time to sort your finances without racking up large amounts of interest every month.

In light of the second national lockdown, the FCA is proposing to extend mortgage holidays and consumer credit payment deferrals. More detail is expected later today, but if confirmed this could provide additional breathing space for those struggling financially.

2. Build up your cash

After dealing with debts your next step could be to build up an emergency pot of cash that you can fall back on should you lose your job, your income is cut, or you face any unexpected costs. Typically a buffer of six months of salary is a reasonable cash buffer, plus any big ticket expenses you know you’re going to have to shell out for in the foreseeable future.

Shop around for the best rate on your savings too. It’s not going to knock your socks off, but every little helps. Fixed term saving products might offer you a better rate if you’re able to lock your cash away for a specified period, typically six months, one year, three years or five years. You can mix and match between instant access accounts and fixed term savings to maximise your return but also making sure you’ve got enough liquidity.

3. Invest regularly for the long term

Once you’re got enough cash to cover any emergencies, it’s time to think about investing for the longer term. While you can still use cash to do this, once inflation is factored in, your savings are likely to be losing their buying power. So an investment in the stock market is worth considering to harvest higher long term returns.

The market is fickle in the short term, but is much more predictable in the long term. Despite the recent sharp falls in the UK stock market and the ongoing shadow cast by Brexit negotiations, it has still turned £100 into £154 over the last ten years. (Source: FE total return to 30 October 2020).

Drip feeding money into the market using a regular monthly investment plan mitigates the risk of putting in a lump sum, only to watch a steep market fall right afterwards. By investing regularly you smooth out the volatility in the market, and also take the anguish and emotion out of deciding when to invest.

4. Rebalance occasionally

You shouldn’t tinker with your portfolio for the sake of it, but sometimes your portfolio can become skewed by market movements, so it pays to check in every now and then to make sure you’re not over exposed to one area. For instance a portfolio that was split 50% in US and 50% in UK stock markets ten years ago would now be 72% invested in the US because the S&P 500 has significantly outperformed the FTSE All Share.

The same thing can occur with individual funds and stocks that are heads and shoulders above the rest of the pack too. It’s clearly positive if they have achieved significant outperformance, but you still need to ensure that you aren’t too heavily reliant on the prospects of one company or fund manager.

5. Use tax shelters

A simple way to boost your returns is to reduce the tax you pay on profits. Investments held within a stocks and shares ISA are not liable to income tax or capital gains tax. On a £100,000 portfolio yielding 4% a year in dividends, that saves a basic rate taxpayer £150 a year, and a higher rate taxpayer £650 a year.

Investments held in a pension are also free from capital gains tax and income tax, and you get tax relief on your contributions too. You can only withdraw your funds from the age of 55 (rising to 57 from 2028) and then 25% is tax free, but the remainder is taxable, depending on your income in retirement.

It’s never been more important to use tax shelters. At some point the Chancellor is going to look at how to pay for the costs of the pandemic, and higher taxes on dividends and capital gains will be in the mix of levers he can pull to restore public finances.

Fund options for investors

For conservative investors:

• Personal Assets Trust: Run by Troy’s Sebastian Lyon, the trust invests in a range of assets including high-quality companies, short-dated government bonds, cash and gold. It’s run with conservative investment principles in mind, in particular minimising losses in falling markets.
• Janus Henderson UK Absolute Return: The fund aims to deliver a positive return, typically over a 12-month period by shorting stocks as well as buying them. It won’t deliver this without fail, but it’s a long term option for investors who want some downside protection when markets are falling.

For adventurous investors:

• Evenlode Global Income: The Evenlode team seek out companies with strong finances that offer predictable earnings growth and the ability to pay a growing dividend. This is a concentrated portfolio of 30-40 stocks which the managers want to hold for the long term
• Fidelity Index World: For investors who want cheap, passive exposure to global markets, this fund tracks the MSCI World Index, giving investors broad exposure to developed markets for just 0.12% per annum.

These articles are for information purposes only and are not a personal recommendation or advice. Pension rules apply. Tax treatment depends on your personal circumstances and rules may change.