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How to Prepare for a Recession

Recessions are a natural, albeit uncomfortable, part of the economic cycle. With the Federal Reserve raising interest rates to curb the high inflation rate (currently over 8%), recession is a real possibility. Some pundits are suggesting we’re already in a recession, which is typically defined as declining GDP (Gross Domestic Product) for two quarters in a row. This we’ve seen, but it doesn’t yet feel like we’re in a recession.  

In most recessions, economic output and employment decline simultaneously. Lower revenue compels businesses to cut back on staff, which leads to higher unemployment. Ultimately, higher unemployment leads to lower consumer spending and that creates a vicious cycle. This year, however, unemployment is still at a record low. The official unemployment rate in August was 3.7% – the lowest since February 2020. A robust labor market makes it feel like we’re not in a recession.

Nevertheless, whether we’re in a short, mild recession already or wind up in a long, deep one in the future, preparing for a recession is prudent. The following tips may help you prepare for a recession and come out in better shape after the recession ends.

Review Your Monthly Spending

Maintaining a budget in good times as well as bad is a great practice. You can’t save if all you do is spend, and the best way to curb spending is to use a budget to eliminate non-essential expenses. In bad recessions, people lose their jobs. Is your job recession-proof or recession-sensitive? What would happen if your hours were reduced, or your position was reduced to part-time? Now may be the perfect time to review your expenses and determine where you can cut back. Could you pause that little-used gym membership or cut back on streaming services? What discretionary expenses can you eliminate to generate additional savings for a rainy day?

Reduce or Eliminate High-Interest Debt

Interest rates are rising. They will continue to rise during a recession, making debt more expensive. Some debt, like mortgages and car notes, is “good debt.” It’s necessary because this debt allows us to meet our essential needs. This debt also carries a lower fixed rate (or should; if you are still in an adjustable-rate mortgage (ARM), meet with your mortgage professional to discuss locking in the rate!), something that we can budget for. On the other hand, some kinds of debt are not good, like credit card debt or payday loans, because they tend to come with high interest rates. It’s not unusual to pay 20% interest with a credit card; the more cards, the more interest, and bad debt can quickly spiral into a nightmare. Get in front of it by limiting the spending that hits a high interest credit card (“If I can’t pay cash for it, I won’t buy it.”). Consider transferring the balance to a 0% interest credit card (0% introductory offers for the first 12 months are common on transfers, assuming satisfactory credit history) and then aggressively paying the balance down or off.  

Build Your Emergency Fund

Maintaining an emergency fund can be a wise practice whether markets are rising or falling. When a recession may be coming, adding money to your savings account can be even more important. Having an emergency fund brings peace of mind, so don’t delay if you don’t yet have one. Typically, an emergency fund contains six months of living expenses, 12 months if you’re working and single. Having that extra cash can keep you afloat if you lose your job, experience a pay cut, or have some other financial emergency. If six months of savings is out of reach right now, start saving because even a month or two of income could help you through a difficult time.

Don’t Make Big Financial Commitments

One of the best ways to reduce expenses is to avoid new ones. When it looks like a recession might be on the way, it may be better to delay large purchases. If you don’t need that new couch or can postpone that big vacation right now, you could put the money into your emergency fund. You may also want to hold off on anything that would increase your existing monthly expenses; this might not be the ideal time to get a more expensive apartment, buy a new car, or expand your streaming services.

Large expenses that require financing are especially tricky when a recession looms because you’re committing to a new monthly bill for a long time. Consider the example of financing a new car. Even if you can afford the payments now along with an increase in your car insurance, a car loan locks you into monthly payments for several years, which could put you in a bind if you lose your job or have a large emergency expense. As long as your current car is serviceable, you could put the money you’d spend on car payments into a savings account so you can spend it on car repairs as needed or use it for a new car when the economic outlook is sunnier. 

Continue to Invest What You Can

Staying invested in the stock market through all parts of the market cycle, with a diversified portfolio that aligns with your risk profile, could lead to long-term investing success. If you’re a buy-and-hold investor already, you might stay the course during a recession, continuing to make your regular contributions to your 401(k), IRA, or brokerage account. It may be upsetting if you see your account value(s) decline, but that’s the nature of investing and the markets will recover as the economy recovers and the recession wanes.  

If you aren’t investing your money yet, take your financial pulse first; if your expenses are well-covered and your emergency fund is stocked, investing during a recession may be the best time to get started. Some people see a recession as a good time to put money into securities that are temporarily lower-priced; again, buying the dip is a sound strategy.  

Summary

News abounds with bad news, including an uncertain economy. Anticipating a recession can be stressful but focusing on what’s within your control and understanding how to prepare for a recession can be empowering. Most experts agree it’s wise to budget, pay off high-interest debt, and build an emergency fund regardless of the economic weather. It may be prudent to put off unnecessary large expenses and continue to invest at lower market levels if you have a sufficient emergency fund. Staying focused on these strategies will serve you well before and after the recession.