Are we headed for a recession? That’s the question many people asking nowadays.
The economy has been temperamental in recent months, with the positives from low unemployment and high job growth offset by rampant inflation and ongoing geopolitical uncertainty (Russia-Ukraine war).
While we are finally moving past the uncertainties induced by the COVID pandemic, the confluence of macro factors above portend flashing warning signs that a recession may be ahead.
In particular the yield curve on bonds (the difference between long- and short-term rates), considered a reliable recession indicator over the past 50 years, recently flattened, and then temporarily inverted; which many economists saw as a troubling sign of tough economic times ahead.
Rising prices have darkened the publics mood about the economy, and consumer confidence (which generally drives US economic activity) has begun to decline in recent months as well.
Taken as a whole, these indicators make it clear that the U.S. may face a recession either this year or the next.
Recessions are more than measures of an economy’s performance; they can have a direct impact on millions of households, often for months or even years. Just look at the fallout from the 2008 GFC.
Economic contractions can mean job losses and erosion of hard earned savings and investments, and overall financial hardship.
Fortunately, there are things you can do right now to strengthen your finances and make them more resilient in the face of economic uncertainty. Here are several helpful steps you can take to recession-proof your finances and give yourself peace of mind in the months to come.
Make a Plan
One of the best ways to prepare for a recession is to get your finances in order before it occurs. If you’ve never had a budget before, take the time to sit down and make one. Then stress test it for scenarios where your income falls and/or your expenses rise significantly. What can your household finances tolerate?
Consider all your current income streams, as well as your weekly, monthly, and annual expenses. Build out your budget over a twelve-month period so you know how your income and bills you have due will affect your financial situation over time.
Use your past months as a guide but ensure you update your forecast budget with significant changes you may be expecting (e.g., new baby or house) and ensure your up your expenses to account for higher inflation. And don’t assume your company bonus or sales commission may be as healthy in the year ahead. Be conservative.
This exercise will help you to visualize your current financial state and determine the best ways to improve it. A good budget will also enable you to assess how major recession shocks such as a loss of a job or other income will affect you, so you are prepared to take steps to mitigate them.
Build an Emergency Fund
Loss of one’s job or income is one of the biggest household threats from a recession. A great way to prepare for the loss of income in an economic downturn is to shore up your savings with an emergency fund.
Having significant cash on hand during a recession will enable you to continue paying key monthly expenses, such as the rent or mortgage and utility bills; it will also ensure there is money on hand for critical repairs to your home or automobile or for unplanned costs like those from medical emergencies.
Additionally, an emergency fund will give you the financial space you need to stay afloat while you pursue a new job or other income options in the event you become unemployed.
If you don’t have an emergency fund right now, start building one right away; even as little as $1000 can help pay bills if you are affected by an economic downturn; ideally, building up to a three- or even six-month emergency fund can help you stave off the worst effects of a recession until you can get back on your feet.
Pay Down Debts
High levels of debt, coupled with high interest rates, in a recession can make riding out tough economic times even harder. The high monthly payments and accruing interest can make it difficult to stay resilient and maintain an already tough financial situation.
If you’re currently carrying too much debt, start prioritizing how to pay it off or lower it right away. If you cannot simply bootstrap it and pay down debt balances altogether, consider using a debt consolidation loan or executing a credit card balance transfer to streamline your debts and make them easier to manage. It’s easier to do this when times are good when credit is easier to get, versus when things tighten.
If your debts are paid off, or at least pared down considerably, you will be in a better position to ride out an economic downturn and allocate your money towards other areas of your finances to mitigate the recession’s effects.
Diversify Your Investments
When you assess your finances, you should also take a close look at your investment portfolio and ensure it is sufficiently diversified.
If your investment or retirement savings accounts (401K, IRA etc.) consist exclusively of one type of security or asset class, such as stocks, it could be more vulnerable to significant losses in a recession.
You can make your portfolio more resilient in the wake of a recession by diversifying it, and ensuring you have investments in multiple types of assets. There are index funds, for example, that are designed to withstand the harshest impacts of economic contractions.
Similarly, spreading stock investments across multiple types of industries can make your investment or retirement account more resilient as well.
Overall, it is wise to consult with a trusted financial adviser to determine the best ways to make your investment portfolio less vulnerable to a sustained recession.
Cut Back on Spending
If a recession seems increasingly likely, you should reconsider your budget and find ways to cut back on spending. The includes current and potential future spending.
Look closely at expenditures that you can do without and start reducing them as soon as you can.
For example, if you are spending a great deal on entertainment, such as streaming subscriptions or dining out, cutting back now will help you start preparing for the worst potential outcomes of a recession, such as a job loss.
Additionally, paring down expenses now, before a recession hits, will enable you to channel that money into your debt reduction efforts, or help you build your emergency find even faster as well.
Reconsider Big Purchases
In line with efforts to cut spending, you should also reconsider your plans to purchase a new home or car if you think a recession is looming
Since one of the biggest potential impacts of a recession is job loss, saddling yourself with a large new mortgage car loan in the wake of an economic downturn can make your financial situation even worse.
To avoid contending with higher debts or bills at risk during a recession, consider delaying major purchases until the threat facing you has passed.
Staying in your current home or keeping your current vehicle in running shape can help you stay more financially resilient and give you one less thing to worry about if a recession hits home.
Alternatively, if you must make a large new appliance or furniture purchase, consider deferring or buying it used/second-hand. There are deals to be had when times get worse, and if you have the cash, you get leverage.
Evaluate your Housing Situation
Housing costs, whether through home ownership or a rental, is often one of the top monthly expense’s consumers have. If you are preparing for a recession, you should consider your housing situation, and determine if there is any way to improve it to make yourself more recession proof.
For example, if you’re renting an apartment right now and the lease is coming due in the next few months, you should consider if it is worth downsizing to a cheaper rental unit, or even taking on a roommate to decrease your monthly expenses.
Similarly, homeowners should consider if now is a good time to refinance or restructure their monthly mortgage payment, or if there is any option to rent out part of their home (e.g. via Airbnb or Verbo) to add another stream of income.
Consider Building New Income Streams
Since one of the biggest threats you’ll face during a recession is job loss, you should definitely start looking at ways to mitigate the effects of lost income right now. One of the best ways to do this is to consider a side hustle, or part time job.
Fortunately, there are more options than ever before to find ways to monetize your spare time. For example. rideshare and delivery services can enable you to turn your idle time into an income earning opportunity.
Additionally, freelancing platforms like Upwork and Fiverr enable users to sell their current skills to people willing to pay for them as well.
Exploring and learning about these and other opportunities now will create options for building your savings and making your income more secure in times of economic uncertainty.
One of the best ways to stay financially resilient during a recession is to keep calm and avoid making rash, uninformed decisions due to panic. Do not cash out all your hard-earned investments or sell of your property because of recession fears.
Instead, you should keep in mind that recessions do occur from time to time (normal part of economic cycle) and are often followed by periods of strong economic recovery and growth.
Instead of panicking, take a long-term approach and make informed decisions that strengthen your financial situation for the long term. Over the long term, staying investing will allow you to buy at lower prices and enjoy the benefits of compounding as the economy and stock markets recover.
Parting Thoughts: Recession Proof your Finances Now
No economist or pundit ever knows exactly when a recession will occur, or if there will be one at all. However, preparing now for a recession can ensure that your finance are ready for the worst shocks of an economic downturn, and can give you peace of mind when storm clouds gather.
So, take the time to assess your financial situation and consider some of the steps discussed here, and start making yourself more recession proof today.