The economy is in a constant state of flux and no one really understands the entire economy at any given time. One of the most prominent cycles that can predict financial gain or loss is the boom and bust cycle that naturally (and artificially) occurs over the years. How can you keep an eye on the economy for this cycle and use it to your advantage?
Boom and bust cycles are a key philosophy that Austrian economists like Magellan can readily predict. Here is what we have learned over the years and how you can benefit from our experiences in the market.
What are Boom and Bust Cycles?
The good news is that you do not need to be an expert in finances to understand the concept of a boom and bust cycle. This term simply refers to the natural progression of the economy in both good times and bad. There will be times when the economy is growing (boom) and then it starts to decline (bust). Many economists simply refer to this as the business cycle.
A boom is characterized by growth in the economy when people are spending money, there are tons of jobs available and filled, and the stock market reflects that. When the economy enters a boom phase, investors tend to get better returns on their investments of all varieties.
On the other hand, a bust is when the exact opposite happens. Unemployment rates reach higher and the economy is less likely to grow and thrive. Investments typically have poor returns during this time and you may lose some money.
There is no set amount of time that a boom and bust cycle will last. Both phases of the cycle can last indefinitely until things start to swing back in the other direction. There are four key phases of the cycle that you need to understand to predict when the economy is moving from one phase to the next: boom, peak, bust, and trough.
- Boom: All growth is moving in an upward direction during a boom, usually with a growth rate that is at 4 percent or more for half the year. Inflation ensues and prices begin to rise, but investors are eager to invest more in the economy.
- Peak: As the boom phase comes to an end, the economy will eventually stop expanding. The peak is the official end of the boom period, characterized by less consistent stock prices and an increase in interest rates as the Fed tries to curb inflation.
- Bust: Lasting less than a year, the bust phase typically comes after the peak when the economy is reversing the trend seen in the boom. Unemployment tends to rise to at least 7 percent and the stock market may crash as well. Recessions are a type of bust that is long-lasting.
- Trough: After the bust, the trough indicates that the economy has bottomed out, and intelligent investors will be looking for deals. The Fed drops interest rates and creates new money to begin a new round of “stimulus.” During this phase, the economy remains stable with neither growth nor decline. It usually shifts into a new boom period eventually.
How to Thrive During Boom and Bust Cycles
The boom and bust cycle is inevitable for all investors, and understanding the various points of the cycle can help you recognize the current market conditions and prepare appropriately.
Magellan uses the boom and bust cycle to reallocate your portfolio as the market shifts. We may help you alter the composition of your portfolio from stocks to bonds as we enter into the bust with the opposite shift during a boom. Rebalancing your portfolio is a crucial component of maintaining your wealth, no matter what season the economy is in.
Beyond understanding the basic tenets of the boom and bust cycle, here is what you should do to protect yourself.
Understanding your finances is absolutely essential to managing wealth during a boom and bust cycle. Creating a budget is a part of most financial planning, and you need to know exactly what your expenses are that must be paid month after month. If you understand your expenses, you can then prepare a “what if” budget when the economy eventually goes into a bust phase.
One of the most important things you can do for your portfolio is diversify your holdings. In some economic seasons, stocks will outperform bonds and commodities, but the opposite can be equally true. Your portfolio should reflect your goals and risk tolerance at any given time. The timeframe in which you plan to cash out your investments also plays a role in how you will diversify your portfolio.
Build Up Savings
It may not be enough to simply rebalance your portfolio and diversify your investments. You also need somewhere to draw from so that you do not have to sell investments during a downturn. To this end, you need a robust savings account that provides you with some financial padding to make it through tough economic times.
Unfortunately, rising interest rates can surface during a boom and bust cycle which makes debt harder to manage. You may end up spending more than you initially planned on your debt due to the rising rates, which can impact minimum payments.
Keep debts low and try to pay the balance off each month to minimize the impact on your budget. Better yet, make a plan to get out of debt completely and stick to it. A debt-free person cares little about interest rates, except as someone collecting interest. That’s the side of a rising rate environment you want to be on.
Get the Help You Need
Investments will always carry risk, but understanding boom and bust cycles will help you protect your hard-earned money. You may need the help of financial experts to make the most of the natural cycles of the economy, but you may really need help managing the artificial cycles that exacerbate it.
Only Austrians can explain the booms and the busts, and only the Austrians can predict them. At Magellan Planning Group, we adhere to the Austrian investment philosophy, leveraging it to help you protect the money that you worked so hard to earn. To make the biggest impact on your wealth, schedule a consultation with us here.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.