While we like to talk about “the economy” as if it’s a static entity, it’s actually more like a living, changing ecosystem. It fluctuates unpredictably, sometimes wildly, and can look very different from one year to the next.
That’s why the threat of recession is always with us. And while the timing is usually an open question, it likely won’t take as long as we’d like for the next one to hit.
Some experts think one may be coming soon. Deutsche Bank, Citigroup Inc., and Morgan Stanley predict that we’ll experience a global economic recession by the end of 2022. So let’s talk about how to prepare for a recession.
What is a recession?
A recession is a period of temporary economic decline where trade and industrial activity are reduced. A recession is usually identified by two consecutive quarters in which the GDP falls (meaning the economy shrinks).
According to the century-old nonprofit National Bureau of Economic Research, a recession can be identified by clear signs and symptoms. The organization defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
This recession definition makes clear that recessions are extremely disruptive to people’s daily lives and financial fortunes, causing everything from layoffs and unemployment to rising prices and shortages. All of these effects were in evidence during the Great Recession of 2008, the worst economic downturn in living memory.
Some of these effects may show up in certain parts of the economy during what may be termed “mini recessions,” wherein economic growth slows but doesn’t entirely stagnate or reverse. In 2015-2016, for example, the U.S. economy went through this type of slowdown. With economic growth still positive and a falling unemployment rate on a national level, the period didn’t meet any usual definition of a recession, but the energy and agricultural sectors, and manufacturers who supply them, felt the pain as those particular industries struggled with a downturn.
Can we predict recessions?
As much as we’d like to be able to anticipate each recession, it’s difficult—if not impossible—to know when one is coming. Even seasoned economists aren’t good seers on this subject. For instance, in May 2007, U.S. Federal Reserve Chairman Ben Bernanke predicted that mortgage defaults wouldn’t do major harm to the U.S. economy. That prognostication aged terribly.
There are some indicators that experts use to sniff out a change in the financial winds that may lead to a recession. A prominent one is an “inverted yield curve,” which means that short-term bond rates are higher than long-term bond rates. While long-term rates are usually higher, these sometimes switch places before a recession hits. If you start hearing this term in the news, it’s best to start getting your finances recession-ready.
What happens in a recession? Just as it’s tricky to predict recessions, it’s also near-impossible to know how a recession will affect you personally. A recession won’t necessarily decimate the value of your investments or result in you getting laid off. You may see rising prices, but it’s hard to know if those will affect the things you typically buy.
Some people may skate through a recession unscathed while others feel deep financial pain. These things are inherently unpredictable, just like the market itself.
How to prepare for a recession
Being prepared for when a slowdown hits means being ready to care for yourself and your family financially if your current situation is forced to change. Here are some specific recommendations:
Step 1: Create a household budget
If you haven’t already, now’s the time to create a budget for your household. This is a key tool to being a good financial planner. Identify how much money you need to earn in order to pay your bills and cover all essential spending. Obviously you want to earn more than this number, but it helps to know your “floor.” If you struggle to make budgets, use one of our recommended budgeting apps.
Step 2: Build your emergency fund
A recession can compound the difficulty of losing a job because not only are you out your usual income but a sluggish economy may make it hard for you to get hired again at a similar salary. When you do find new work, you may be forced to take a pay cut or work more hours for the same pay, which will result in financial pressure unless you have savings to make up the difference.
Therefore, your next step to prepare yourself for a downturn is to save up a substantial chunk of money to serve as an emergency fund. Experts recommend keeping three to six months of living expenses in a high-interest savings account. This money should be sacrosanct, only to be touched in the event of an unexpected emergency like losing your job or having your hours at work severely curtailed.
Step 2: Examine your expenses
An emergency fund will only go so far to support you in the event you lose your job, become injured, or struggle with a major expense. If you think a recession is around the corner, it’s a good idea to make sure you’re living as lean a lifestyle as possible before the worst actually happens.
Sit down with your family and examine your spending to find areas where you can tighten your belt. Some items that may be on the chopping block are eating out, buying expensive clothes or gifts, and spending on hobbies and vacations.
Step 3: Pay down debt
Working to pay down high-interest debt when the economy is booming is like doing your future self a favor. You can start paying extra capital while things are good in order to pay your debts off faster. You could consolidate high-interest debt to get a lower average interest rate or enter credit counseling if your debt is a burden. Getting your debt payments under control is essential, since having good credit will help you weather future financial storms.
When it comes to debt management, you have a few options: A popular way of paying down debt is the “debt snowball” method, which involves paying off your smallest loans first to give you some early wins that can motivate you to tackle your bigger loans.
Another option is the “debt avalanche” method, which has you pay down your high interest debts first, no matter the size of the balance, and work your way down to the lowest-interest loan. If you aren’t sure which approach is right for you, reach out to a financial planner.
Step 4: Gain employment and side-hustle skills
One of the major concerns people have about recessions is the potential for job loss. Layoffs are common when the economy takes a nose-dive, and getting a new gig can be tricky when no one’s hiring. One good thing to do while the economy is healthy is to pick up some in-demand skills or credentials to make yourself more attractive on the market in case you need to look for a new job in a down economy.
Another option is to pursue skills that you can perform on a contract basis so you’ll be able to find smaller jobs as a stopgap if your main income source dries up. Once you’ve got those skills, you can use them as a side hustle to earn extra income that you can stash away in your emergency fund or use to pay down more of your debt.
Step 5: Set up access to additional credit
Along with recession-proofing your job skills, it can be a good idea to enhance your financial resources for potential future needs. You can access additional credit through a home equity line of credit or some new credit cards with higher limits. Keep those resources open and don’t use them before you have to.
If you have credit card debt already, it is a better idea to pay those down as fast as you can to free up credit than to apply for new credit cards. Consolidating your credit card debt using a personal loan that allows it is another good way to increase credit flexibility while also reducing your average interest rate.
Step 6. Make use of aid programs
There are countless government programs (permanent and temporary) at the federal and local level to help people struggling with financial hardship. For instance, some governments offer low interest loans, temporary moratoriums on foreclosures and evictions, free school lunches, food programs, etc. Don’t be afraid to take advantage of these programs if you need help. Research your options carefully to find those that apply to your situation.
Step 7: Keep investing
Before a recession hits, review your investment portfolio to ensure that it fits the level of risk you’re comfortable with. How much risk you will want to assume depends on your attitude and personality, your financial goals, and your time horizon. Those near retirement will want to be far more conservative in their investments than younger people who want growth.
Once you’ve adjusted your investment risk, don’t stop investing in the stock market during a recession. The stock market will almost certainly go up again, so it’s not prudent to yank all your money out at the first sign of trouble. Consider staying the course and buying shares of a diversified asset mix even when the market falls.
If you take all this advice, you’ll be in the best position possible when the next economic recession comes along. Boosting your financial stability and flexibility should be the centerpiece of your personal recession-proofing.
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