How to Recession-Proof Your Finances
With credit card debt and federal interest rates on the rise, many financial experts believe we are headed toward a recession. As we brace ourselves for turbulent economic conditions, it’s good to explore actionable steps you can take to recession-proof your finances.
What is a Recession?
A recession is a decline in the gross domestic product (GDP) for two consecutive quarters. Recessions can last for months or years. During a recession, the decline in GDP is accompanied by rising unemployment rates and reduced consumer spending, which exacerbates the situation.
What Causes a Recession?
A recession is caused by an imbalance between supply and demand. In other words, there is a mismatch between the products consumers want to buy, the amount of goods and services being produced, and the cost of those goods and services.
An impending recession is usually heralded by rising inflation and federal interest rates. Inflation increases when the cost of goods and services increases.
Many experts agree that a recession in 2023 is likely to be caused by a rise in federal interest rates to quell inflation.
Digging deeper to find out what caused the inflation will help you understand the big picture.
As the video explains, rises in inflation and interest usually have underlying causes like natural disasters, wars, and geopolitical events. These shocks can cause major interruptions in spending or access to important commodities that disrupt the supply side of the economy. When supply is disrupted, the cost of goods increases which discourages demand – swinging the pendulum toward production cuts, including labor and wages. The result is an unstable economy.
6 Ways to Protect Yourself From a Recession
- Build An Emergency Fund
- Protect Your Personal Income Streams
- Downsize Your Spending, if Necessary
- Protect Your Investments
- Avoid New Debt
- Pay Off High-Interest Debt ASAP
1. Build An Emergency Fund
Building an emergency fund is particularly important because it can protect you from financial hardships that may be triggered by a recession, like job loss, pay cuts, and other unexpected emergencies. Here are some steps you can take to build an emergency fund to protect yourself during a recession:
- Determine how much you need: Experts recommend having at least six months to a year’s worth of living expenses saved in your emergency fund.
- Set up automatic savings: Set up an automatic transfer from your checking account to your emergency fund savings account each month. This way, you can consistently add to your emergency fund without having to think about it.
- Look for ways to increase income: Consider taking on a part-time job or freelance work and direct this income into your emergency fund.
- Keep your emergency fund separate: This way, you can clearly see how much you have saved and resist the temptation to dip into it for non-emergency expenses.
2. Protect Your Personal Income Streams
Preparing for a recession means protecting your income streams so that you have the financial stability to weather the storm. You’ll want to ensure that what you bring to the table at work is indispensable and as safe as possible
- Become indispensable and adaptable at work: Focus on professional development by learning new skills and adapting to change with a willingness to learn and expand your role.
- Stay up to date on industry trends: If you work in a specific industry, stay up to date on industry trends and changes that may impact your job or income. This can help you prepare for any potential changes and pivot if necessary.
- Diversify your income: If you rely on one source of income, such as a full-time job, consider diversifying your income streams by starting a side hustle or freelance work. This way, you have multiple sources of income to rely on if one dries up.
3. Downsize Your Spending, if Necessary
If you do not have adequate emergency savings, have a lot of debt, or are consistently outspending your income, downsizing your spending is an important step to take. Downsizing your spending will help you funnel cash toward savings, investments, and paying down debt.
- Create a budget: The first step to downsizing your spending is to create a budget. This will help you see where your money is going and identify areas where you can cut back.
- Cut back on non-essential spending: Look for ways to cut back on non-essential spending, such as dining out, entertainment, and subscriptions. Consider more affordable alternatives, such as cooking at home or having a movie night in.
- Shop smarter: Shop around to find deals and discounts when shopping for groceries, household items, and clothing. Buying second-hand items or shopping at discount stores is a great way to get the things you need for less.
- Reduce your transportation costs: Consider carpooling, taking public transportation, or walking/biking instead of driving. This can save you money on gas and car maintenance.
If you already have an emergency fund and do not have debt, downsizing spending may not be necessary. Still, it’s always a good idea to look with a critical eye at your budget to ensure that you aren’t spending mindlessly.
Even if you aren’t living paycheck to paycheck, you’ll likely find places where you can cut back on spending that isn’t essential or add something meaningful to your quality of life.
4. Protect Your Investments
Diversifying your investments is an important step in preparing for a recession. Here are some ways to diversify your investments:
- Make sure your portfolio is diversified: You should be doing this already, but if you aren’t, make sure that your portfolio includes different asset classes (stocks, bonds, Stocks, bonds, ETFs, real estate, etc.) and stocks from a variety of sectors (technology, healthcare, consumer goods, etc.) Each asset class has different risk and return characteristics, which can help balance your portfolio.
- Avoid the urge to sell when things drop: Rebalancing your portfolio — which involves buying and selling investments to restore your original asset allocation or a mix of stocks, bonds, and other investments — is usually a good idea, but not during a market sell-off.
- Consider buying “during the dip”: If you have the resources, buying stock when prices fall during the recession can be a way to build the value of your portfolio when the economy recovers. But remember, this type of buying carries risk. You should only buy the dip if you can tolerate losing that money.
- Work with a financial advisor: A financial advisor can help you create a diversified investment portfolio that fits your goals and risk tolerance. They can also help you make adjustments to your portfolio as market conditions change.
By diversifying your investments, you can reduce your portfolio’s risk and prepare for a recession. Remember, diversification does not guarantee against loss, but it can help protect your portfolio over the long term.
5. Avoid New Debt
Avoiding new debt before a recession is a smart financial move. If your income is impacted during the recession, debt can quickly torpedo your recovery efforts and have catastrophic consequences for your long-term financial health.
- Prioritize growing your emergency fund: If you have emergency funds saved, it is much easier to avoid taking on debt.
- Use cash or debit cards: Use cash or debit cards for purchases rather than credit cards. This can help you avoid taking on new debt and keep your spending in check.
- Avoid taking out new debts: It’s best to steer clear of new unsecured debts, such as personal loans and credit cards, or secured ones, like home equity lines of credit with variable interest rates. If your financial situation takes a turn for the worse, these debts can create an unmanageable amount of financial stress.
6. Pay Off High-interest Debt ASAP
Paying off high-interest debt should be a priority regardless of the state of the economy. Making minimum payments on high-interest debt, such as credit cards or personal loans, is a losing game. Paying it off as soon as possible will protect your long-term financial health.
- Make a budget: The first step is to make a budget to understand your expenses and income. This will help you determine how much money you can allocate to debt repayment each month.
- Focus on high-interest debt: Identify the debt with the highest interest rate and focus on paying it off first. This will help you save money on interest payments in the long run.
- Consider debt consolidation: If you have multiple high-interest debts, consider consolidating them. This can simplify your payments and potentially save you money on interest.
- Increase your payments: To pay off your debt faster, consider increasing your monthly payments. Even small increases can add up over time and help you pay off your debt sooner.