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Updated on Friday, July 30, 2021
Anyone who lived through a recession knows that it can cause financial pain, no matter your level of wealth or employment status. This means that preparing for a recession is always the right move for your financial well-being.
It’s been more than 10 years since the Great Recession ended, which marked the close of the longest economic contraction since the Great Depression of the 1930s. Over the past decade, we have seen the longest economic expansion in U.S. history.
Many people wonder how much longer the current economic expansion will last and when the next recession might arrive. It’s impossible to know, so you should start to prepare for the next recession today.
How to prepare for a recession
The best way to prepare for a recession is to monitor and improve your financial health while the economic outlook remains positive. The list of things you should do to improve your finances isn’t long, and making solid financial plans isn’t a complicated formula.
“It’s the same advice you should generally always be following,” said Tendayi Kapfidze, chief economist at LendingTree, MagnifyMoney’s parent company. “The world is a risky place, and income is not always guaranteed. You should always be doing things to shore up your finances.”
8 things you can do to prepare for a recession
1. Build up your emergency fund
“The main challenge a recession creates is it could create some interruption to your income,” Kapfidze said. To protect yourself from a decline in income or a job loss, you should have enough money to pay at least three months of expenses stashed in your emergency fund — six if you have children.
Wherever you keep your emergency fund — in a savings account with a bricks-and-mortar bank, an online savings account or even a money market account — the most important thing is to keep the fund liquid. You don’t want to be forced to pull money out of the stock market during a recession.
According to Dennis Nolte, a certified financial planner who works for commission and fees in Winter Park, Fla., if you’re young and financially secure, you might consider investing part of your emergency fund in a Roth IRA. You can withdraw contributions from a Roth IRA at any time without paying tax penalties. You have to leave earned interest in the account, however, because withdrawing interest would trigger penalties.
In case your bank fails during a recession, make sure you deposit funds into an account offers FDIC or NCUA insurance. These institutions cover $250,000 per depositor, per institution. This type of insurance is re-assuring in the unfortunate circumstance that a bank or credit union fails.
2. Pay down debt
As a recession looms, one key strategy to protect yourself is to pay down debt. This helps to increase the amount of extra liquidity you have on hand when a recession hits.
“This is the best risk management tool,” Nolte said. He suggested that you prioritize paying off high-interest credit card debt.
In addition to directing available funds to pay off debt, consider refinancing or consolidating your debt at lower interest rates. This can reduce how much you pay in interest, decrease your monthly bills and increase the funds available for saving or paying down even more debt.
3. Review your investing strategy
It’s important not to let a looming recession dictate your investing decisions. In other words, don’t try to time the stock market. Instead, prepare for a recession by maintaining good habits at all times: Build a deliberate investing strategy, and stick with it.
“The best thing people can do now is verify that their portfolio is appropriate for them,” said Angela Dorsey, a fee-only certified financial planner based in Torrance, Calif. “If it’s too risky, you should make changes now.”
Determine that you have the right investment mix
Over the past few years, many people invested aggressively in equities as the stock market climbed higher and higher. Now, it’s time to ask yourself how you would feel if the market fell 20% in one year.
Be honest: If you believe that you can tolerate a loss of this magnitude, stick to your plan when the market falls, and stay on course. You should hold on to your investments particularly if you’re young, because time is on your side, and you’ll have lots of time to recover losses in a stock-heavy portfolio.
Dorsey recommends that you rebalance your portfolio if it strays too far from your strategic allocation, or mix of stocks, bonds and other securities.
Kapfidze agrees. “You want to have a balanced portfolio that meets your long-term goals,” he advised. That should be the goal regardless of where we are in the economic cycle.
For example, your plan might be to have 70% of your investments in stocks and 30% in bonds. The market has gone up, so a larger percentage of your portfolio now might be in stocks, say 75%. So, you should rebalance your portfolio — sell stocks and buy bonds — to reach your goal of 70% stocks and 30% bonds.
Change your strategy for peace of mind
Your portfolio should be appropriate for your risk tolerance. If you’re nervous about an economic downturn and believe that big losses in your retirement savings would keep you up at night, the time to reallocate is now.
Consider the strategy above: 70% in stocks and 30% in bonds. If you believe that you couldn’t endure a huge drop in the equity markets, now might be the time to change your allocation to, say, 50% stocks and 50% bonds. Just don’t wait for the market to tank to change it up, though.
“When you’re not emotional about it, when it’s not free falling like it did in 2008 or in 2001, 2002, you can make some adjustments,” said Scott Bishop, a fee-only certified financial planner in Houston. That’s because now “you can see if there [are] some flaws in your portfolio that might be subject to market risk by lack of diversification.”
4. Diversify your income with a side gig
When we think of diversification, we tend to focus on our investment allocation, but the idea can and should be applied to sources of income as well. Because a loss of income is one of the biggest threats during a recession, having multiple income streams can help to lessen the effect from a reduction in income or a job loss.
Millions of Americans have a side gig. If you don’t, now could be an excellent time to consider one. Do some research and identify a side gig you can pick up now to protect yourself against potential income reductions later.
5. Reduce your living expenses
Don’t wait for a recession. Now is the time to trim the fat in your spending. Review your recurring fixed monthly payments as well as your discretionary spending. See what you can eliminate, and reduce or downgrade services that aren’t vital to your household. Consider becoming conservative with your discretionary spending in favor of stocking up cash and paying down debt.
6. Assess your current job and employer
When you prepare for a recession, don’t monitor only national economic conditions: Take a closer look at circumstances close to home.
“Understand how well your employer is doing financially, because that may help you better assess your risk,” Kapfidze said. Trends in your company and your industry affect you more directly than what happens on a national level.
Employees of public businesses can stay abreast of company and industry happenings by listening to their company’s earnings calls.
In addition to knowing the state of your company, employees should find ways to insulate themselves against a potential job loss. Kapfidze suggested taking steps to increase your value to your company in your current role, such as increasing your knowledge and skills and taking on additional responsibilities.
7. Set aside cash for short-term goals
If you have money invested in the market for short-term goals, such as repairing your roof or buying a car, it’s time to shift gears. That money should be kept in an interest-bearing account, so it won’t be influenced by the stock market.
“[This] should be the case anyway,” Dorsey said. “But over the last few years, people have gotten a little too ambitious and say, ‘Oh gosh, I want to buy a house in five years, so let’s be super aggressive and put it all in stock, so it can grow.’ They can grow, but they can also go down.”
8. Don’t let fear drive your decisions
Recessions can be difficult, frightening times. A common pattern that financial planners see is that people act based on emotions and fears.
“When they are emotional, people tend to buy on greed when the market’s going high and sell on fear when the market’s going down,” Bishop said. “If you’re buying high and selling low, you’re doing exactly the opposite of what you need to do to make money in the market.”
A recession is a normal part of economic life. With your retirement savings, you have to keep a long-term perspective, because another economic expansion will arrive after a recession ends.
The bottom line: Don’t panic or allow your emotions to get in the way when the next recession hits. Instead, prepare for it now, and you’ll breathe easy later.
A recession is when the economy contracts, or gets smaller, for an extended period. Recessions are part of the economic cycle, and they’re followed by a period of economic expansion.
One marker of a recession is six consecutive months of negative gross domestic product (GDP). GDP measures the market value of all goods and services produced by the U.S. economy. However, six months of negative GDP isn’t the only determining factor for a recession.
The National Bureau of Economic Research (NBER), which designates recessions, also looks at real income, employment, industrial production and wholesale-retail sales.
Since 1945, recessions lasted 11 months on average. However, they can extend significantly longer. The Great Recession, for instance, lasted 18 months. History shows that the United States experiences a recession roughly every six years.
Although recent recessions last 11 months on average, consumers and businesses feel a recession’s effects for years or even decades afterward. Long-term unemployment or reduced wages can affect individuals and families in multiple ways.
For example, if a family no longer can afford to send their kids to college because of a job loss or depleted savings, the missed educational opportunity for that child can affect their earning potential and their future family.
In the last recession, many people lost their home to foreclosure, a blow to their personal finances that can take years to recover from. Long-term unemployment not only has a financial effect, but also an emotional one as well.
Plus, reduced earnings mean reduced buying and fewer dollars rotating in our economy, which results in further lost opportunities for consumers and businesses alike.
Trying to time a recession isn’t something the average person should try to do, Kapfidze said. “Professionals try to do that, and they lose money every day.”
Nevertheless, a recession can provide an excellent opportunity to buy assets at “discounted” prices. Kapfidze suggested waiting until the economy shows signs of recovery before you take the plunge, because trying to predict the bottom of the market also is risky.
“Don’t try to catch a falling knife, because you might grab it by the blade instead of the handle,” he warned.
“There are various things you can look at to assess the risk of recession,” Kapfidze said. One is the yield curve, which measures the difference between long-term and short-term interest rates. A lot of discussion about the risk of a recession in 2019 centered on the yield curve, but that chatter has died down.
“[That] doesn’t mean the recession risk is materially lower,” Kapfidze explained. “It’s probably a bit lower, but it could still happen within six to 18 months. That’s a pretty wide window.” Of course, there’s no guarantee that a recession will happen in that time frame. “Recently, the economy has looked a little bit better than it did a few months ago.”
Things can change rapidly. Earlier this year, the sentiment was negative, Kapfidze pointed out. “It can turn positive pretty quickly, and it can turn a little more negative pretty quickly.”
Again, Kapfidze stressed that instead of focusing on the timing of the next recession, consumers should take prudent steps to firm up their finances. “That increases the odds of success and certainly is way less stressful than trying to figure out where I am in the business cycle and what are the odds of a recession.”