There are four stages of the business cycle: expansion, peak, contraction and trough. We’ll look at these and other cycles and draw some conclusions about the economy and how you can plan for the future.
Experts Have Discovered That Economic Events Happen in Cycles. The Seasons, the Planets and Human Life Itself Are Cyclical
Before we get to the details of the four stages of the business cycle, let’s discuss more about economic catastrophe. Unfortunately, the American Great Depression and the COVID-19 shutdown of 2020 were catastrophic events. Yet, some very intelligent researchers have determined that much of what we experience in our lives revolves around cycles.
The sun and the moon follow a cyclical pattern that is predictable. In addition, the earth’s movement through the universe and its relationship to other stars is part of a greater cycle. But here on earth, there are many more cycles.
The life of a human being is part of a cycle. You are born, you become a youth, then middle aged, followed by elderly life and death. Our season are cyclical: Fall, Winter, Spring and Summer. Researchers have discovered that our economy is cyclical as well. Oddly enough, the four stages of the business cycle are closely related.
According to Investopedia, the four stages of the business cycle are as follows:
“The four stages of the economic cycle are also referred to as the business cycle. These four stages are expansion, peak, contraction, and trough.” -Investopedia
The Four Stages of the Business Cycle: Expansion, Peak, Contraction and Trough
Expansion occurs when the economy is growing. Prices begin increasing, more people are working. Businesses grow and make more money, hire more workers and pay better salaries. The workers tend to spend more money, buying cars and houses, passing money along through the economy. Most participants in the economy benefit and see more money in their bank account.
The peak of the business cycle is the highest point. It occurs when expansion reaches its maximum. For example, employment in the economy is considered full, prices increases are beginning to look like inflation. Many people will have borrowed great deals of money for bigger houses or more things. The stock market is usually at an all-time high.
During a contraction economic growth begins to slow down. Inflation (price increases) begin to slow down as well. In addition, unemployment may begin to increase and more people find themselves out of the workforce. The stock market may level off or even begin a correction or retracement. New housing starts may decrease during this time period.
The trough is the low point and may also be called a “recession” or a “depression.” People begin to worry about personal finances. Unemployment is higher, borrowing money is more difficult and people struggle to make ends meet. The stock market may be in a bear market trend either going down or flat. Jobs are scarcer and the real estate market is tight.
Economist Ray Dalio and the Economic Machine
Ray Dalio, an economics expert from Bridgewater Associates, has created some really intelligent free videos on understanding the 4 stages of the business cycle. He also is the author of the book, “Principles.” Dalio is really good at simplifying economic ideas and helping you understand why things happen as the do.
How the Economic Machine Works by Ray Dalio
Why You Need to Know About the Four Stages of the Business Cycle
During the up Cycle the Economy Flourishes; During the Down Cycle the Economy Suffers
It’s important to understand the basic concept of economic cycles because cycles go up and down. The economy bounces back and forth between growth and recession. In down cycles, money is tight, banks are reluctant to lend money, economic growth slows down and people don’t spend as much because they have less money. However, in up cycles, people spend more, banks lend more money, the economy grows and unemployment is low.
There are many investments in the economy that are affected by the economic cycles, such as the stock market, real estate prices and even commodities prices like gold and silver. As a result, financial planners and investors must be proactive in planning for changes during the four stages of the business cycle.
The American Economy is in a Down Cycle in 2020
In 2020, the economy is passing through a down cycle. We are probably somewhere between contraction and trough in the four stages of the business cycle. As a result, unemployment is high, it is becoming more difficult to borrow money and yet the stock market is at an all-time high. Money managers have to make tough decisions about re-balancing portfolios with stocks, bonds, precious metals and even cryptocurrencies.
What You Can Do to Thrive and Protect Yourself
The Secret to Winning in the Four Stages of the Business Cycle: Budget, Save Money & Invest
When life is cyclical, it simply means things go up and then they go back down. The pattern repeats itself in a cycle that goes on forever. Moreover, in the natural world, animals are aware of the cycle of the seasons. For example, squirrels have the natural instinct to bury acorns during the summer and build their nests to prepare for the bitter cold of winter.
In many ways, the four stages of the business cycle operate much like that in the animal kingdom. Although humans no longer depend on instinct to survive, we can still use our higher brain function to make decisions. If we know that the economic cycle goes up and down, then sometimes we will have more money and other times we may have less money. Following this logic, it makes sense for us to save money during the times that we have more money. When we learn ways to save money on a tight budget, we are better prepared to weather the storm of bitter economic times.
Write Down Your Goals
If you want to be retired, living on a beach in Costa Rica in 20 years, then you need to write that down as part of your goals. We recommend creating a notebook, journal or even a spreadsheet where you list exactly what you have planned for the future. This serves two purposes. Writing down your goals makes what you want explicitly clear. It gives you a starting point and also provides you with the details that you will need to determine how you will reach your goals.
The second purpose of planning out your financial goals on paper (or electronically) is that you are signaling to the universe what you want. History has proven that the psychology of desire and intention is a powerful tool in accomplishing goals. Understanding the four stages of the business cycle can help you achieve your financial goals as well.
Review Your Goals Regularly
Once you’ve written down what you plan to accomplish through your goals, you should return to the goals frequently to review them. Some people even find it helpful to place a copy of the written goals in a location near them where they see the goals daily, like on your bathroom mirror or near your workspace. It can also be helpful to visualize your goals through imagery. Is one of your goals to own a beach house? Place a picture of the beach house that you want on your wall. Again, the power of intention is great and tends to help you focus your energy on exactly what you want.
Create a Budget
Now that you have established your goals, it’s time to create a budget. Budgeting requires a great deal of self-discipline, so if you don’t follow your budget, then it can wreck your plans! When you create a budget, start by writing down in detail what your expenses are each month.
Spreadsheets are great for budgeting, but not required. There are also budgeting apps to choose from that can be helpful. For now, you need to know where you spend your money. Provide as much detail as possible when listing your expenses. You may find it helpful to review past bank statements and receipts.
Once you have an idea of where you spend your money each month, it’s time to take a hard look at your budget and cut some expenses. Many people find making cuts to spending a difficult task. But making cuts now will help you reach your financial goals quicker.
Living Below Your Means
After cutting your expenses down to the bear minimum, you should be living below your means (hopefully). Unfortunately, living below your means is a philosophy that most people don’t follow these days. Living below your means requires that you spend less than what you make. For example, if your take home pay is $1,500 per month, then living below your means is only spending $1,000 per month.
The extra money that you have from living below your means will serve two purposes. At first the extra money will be used to pay down debts quickly. Getting ahead requires that all debt be paid off first. Secondly, after the debt has been paid off, you will then use the positive cash flow to fund your emergency fund, savings and investments. Each of these is part of your net worth and the buffer between you and poverty. The more you can grow your savings and investment, the simpler and easier life gets.
Pay Off All Debts
Before you can start saving money, you must pay off all debts. Now that you’ve established your budget, cut personal spending to the bare minimum. You will take extra money that you have leftover in your budget and use it to pay down debts. Create a list or accounting of your debts, the corresponding balances and interest rates that you maintain. Use this information to help you keep track of your progress as you pay down debts.
If you are young and just starting out, hopefully your debts are minimal. Having minimal or no debt when you begin your journey toward wealth creation is a huge advantage. Paying off debt can take years and a great deal of sacrifice. So, if you have little or no debt, congratulations! For the rest of us, it’s time to get to work paying off debt.
The Shocking Truth About Saving Money
According to a December 2019 article by GoBankingRates, approximately 70% of Americans have less than $1,000 in savings!
This is a shocking statistic that shows how access to credit cards and lending have dominated our society. Unfortunately, Americans have adopted the idea that borrowing money for most things is normal. Yet, just a few generations ago in the early 20th century, people learned the hard way during the Great Depression that borrowing can lead to financial ruin. Having no savings puts you in a dangerous financial place.
Make Saving a Habit
Saving is a habit that can be learned over time and simply requires discipline. Become determined to reach your financial goals. Your personal determination to win at the money game will help you develop the discipline to save.
In addition, develop good habits of saving money. In the classic personal finance book, “The Richest Man in Babylon” by George Clason, the author implores the reader to set aside at least 10% of your earnings. This is a great rule of thumb for saving and investing because removing only a fraction of your income each month will likely not even be noticed or missed. Yet, this small amount of money is the seed needed to grow wealth.
Create an Emergency Fund
The first thing to do when you have paid off debt is to start saving for an emergency. Many people think that saving for an emergency is not necessary, until life proves them wrong and an unexpected event happens. Unfortunately, we all have emergencies during life: job loss, medical issues, natural disasters, home repairs, car problems, etc. Life is expensive and it pays to be prepared.
At a minimum, you want to have at least $1,000 in your emergency fund. In reality, your emergency fund should cover 3-6 months of expenses. For most people this number should probably be between $5,000 – $20,000. Keep in mind that in the worst case scenario you want to be able to pay all your bills and eat for 3-6 months, in the event that you lose your job.
Invest 10-15% of Income
Once you’ve fully funded your emergency fund, you can start investing. And if you have made it this far, then congratulations! You are ahead of the pack and well on your way to wealth building.
As stated previously, we recommend that you invest 10-15% of your income monthly. The earlier that you get started saving and investing, the better off you will be in the long run. In fact, the most powerful tool that will be working for you during investing is compounding interest, and it works like magic. How do you turn $1,000 into $62,000? The answer may be simpler than you think.
Wrap Up: the Four Stages of the Business Cycle
As you can see, understanding the four stages of the business cycle is critical in understanding how investing works. Knowing the parts of the business cycle makes investing and managing money clearer and reduces the chances that you lose money over time.
It is important to note that Piggy Bank Coins does not provide financial advice. We don’t endorse or recommend any financial investments. Instead, we provide information for educational purposes to those seeking knowledge regarding personal finance. However, in the spirit of transparency, note that the author is an investor in cryptocurrencies, precious metals and some equities.
In addition, The Federal Trade Commission (FTC) requires that Piggy Bank Coins disclose to readers that we may receive commissions when you click our links and make purchases. However, this does not impact our reviews and comparisons. Moreover, we try our best to keep things fair and balanced, to help you make the best choice for you.