Wouldn’t it make our lives as financial planners easier if the four phases of the business cycle were consistent and predictable? YES. But where’s the fun in that?
Instead, navigating the business cycle is kind of like riding a roller coaster. You’re going up, up, up, and it’s exciting, but you’re holding your breath as you wait to reach the top. Then, there you are, at the crest. You can breathe, take a look around, but right before you settle in, you start the plunge to the bottom. Then it’s up, up, up again. Sometimes the ride to the top takes forever, sometimes not. Sometimes the plunge goes deep, other times, it’s just a little drop before you’re headed back to the top.
The business cycle is kind of like that. But just like with roller coasters, knowing what to expect and how to anticipate and respond to the ups and downs will make the journey a lot less scary (for you and your clients).
Let’s walk through the four phases of the business cycle, from what they are and the signs of a shift to best practices to safeguard your clients’ financial goals and strategies.
Listen up: Jerry and Adam talk about business cycles and economic indicators, specifically looking at leading and lagging indicators. Spoiler: new building permits can be an early sign of an economic shift!
Economies move through four phases:
Expansion is when the economy is growing consistently. The GDP is rising, jobs are plentiful, and businesses are investing. This environment fosters confidence, and confidence can power even more growth.
Key Characteristics of Expansion:
It depends on economic and policy factors. Sometimes the expansion phase of the business cycle only lasts a few years, but sometimes, they go on for a surprisingly long period. The U.S. was in an expansion phase from 2009 to 2020—11 years!
When you’re in the expansion phase of the business cycle, consider taking these steps to make the most of the positive economic environment for your clients:
Growth has to stop somewhere, and that’s what leads to the second phase of the business cycle: peak. At the peak, the economy hits its highest point, then seems to pause. Demand is strong, but costs—especially for labor and raw materials—may rise sharply. Overconfidence can breed excess, and you’ll often see bubbles forming. The dot-com bubble of the late 1990s is a good example of the peak phase where stock valuations soared and unemployment was low, but prices and interest rates started rising before the crash.
Peaks are usually short-lived—often just months. It’s a sign that change is on the horizon.
If you see signs that the business cycle has reached its peak, consider taking these actions:
The third of the four phases of the business cycle is the contraction, or recession. The economy slows down or even reverses course, and you’ll see slow growth, increased layoffs, and drops in consumer spending. This phase can quickly drag down a portfolio, but careful planning makes all the difference.
Contractions last an average of 11 months, but severe recessions can continue for longer. The Great Recession lasted from December 2007 to June 2009, for a total of 19 months. This was the longest recession in the United States since before World War II.
As soon as you recognize that the business cycle is shifting to the contraction phase, consider taking these steps. This is where strategic and quick planning can make a huge difference in the financial future of your clients.
The trough is the cycle’s lowest point, but there’s nowhere to go but up, right? The trough is the launchpad for the next recovery, so while clients (and you!) may feel discouraged, history shows that recovery will occur—usually sooner than most people expect. For example, in the recession of the early 1990s, the trough occurred in March 1991 with a GDP of $8.87 trillion. But by the end of 1991, the business cycle was well into expansion with a GDP already over $9 trillion for the first time.
Troughs are typically short, sometimes just a few months, before recovery begins.
Economic Indicators to Watch:
Once you see the contraction is over and the business cycle has moved into a trough, take these steps to get ahead of the upcoming expansion:
CFP® Exam Tip: Work towards articulating what is occurring in the economy at each point in the business cycle. You should also be able to identify where the economy is likely headed given current conditions. Questions will often “set the stage” for you with an overview of the economy and ask you to identify the phase in the cycle.
While you can’t control the business cycle, understanding its phases and knowing how to read the signs of it will help you guide your clients through the ups, downs, and sharp turns. As a CERTIFIED FINANCIAL PLANNER®, you’ll learn the ins and outs of investments, taxation, risk management, and other advanced financial planning concepts.
Having more tools in your toolbox will give you more options when it comes to creating financial plans for your clients, which is always a good thing! And at BIF, we can help you earn your CFP® marks in less than a year! Check out our free ebook, Become a CFP® Professional with BIF, and learn the requirements and how BIF provides a seamless, supportive experience as you work towards your career goals!