How to Prepare for a Recession
From the Federal Reserve to the workplace water cooler, people are wondering whether a recession will hit sometime in the year ahead. If you share this concern, this recession-prep checklist can help you prepare to weather an economic downturn.
What is a recession-prep checklist?
It’s a point-by-point review of all aspects of your financial situation. Basically, it’s designed to help make sure your assets and debts are in the best shape they can be for a potential downturn in the economy. It can help you look after both your income and your spending, and consider both short-term and long-term impacts to your finances.
Why Get Ready for a Recession?
What’s at stake? Recessions are part of the cycles the economy goes through. Think of those cycles as including both good times (economic expansions) and bad times (recessions).
The good news is that the economy has been in an expansion for over ten years now.
The bad news is that, since the end of World War II, the average expansion has lasted just short of five years, according to the National Bureau of Economic Research. So you could say we are overdue for a recession.
Many people lose their jobs in a recession and the unemployment rate goes up. The value of financial assets like stocks and real estate tends to go down. It can be very difficult to get a loan after recession hits. On average, these economic downturns last 11 months, but the last one went on for a year and a half.
A sustained economic downturn can be devastating to your finances, but being prepared can make it easier to wait out a recession.
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8 Ways to Help Keep Your Finances Recession Proof
1. Build up your emergency fund
Millions of Americans lost their jobs in the last recession. Worse, because the economy was so weak, it often took unemployed people a long time to find a new job.
At one point during the aftermath of the Great Recession there were over 7 million Americans who had been unemployed for more than half a year.
It helps to have cash reserves set aside to help pay the bills during an extended period of joblessness. An emergency fund can give you some money to fall back on when you need it.
Even if you don’t lose your job during a recession, credit can be difficult to get. An emergency fund can also come in handy for unexpected expenses like a medical bill or car repair.
What is an emergency fund?
An emergency fund is money that can be accessed on short notice. Savings accounts and money market accounts are common vehicles for emergency funds. A CD can also be used if you choose one with a low early-withdrawal penalty.
In any case, if you are concerned about a recession, now is a good time to start building up your emergency fund until it is able to cover at least six months of your most necessary expenses.
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2. Shift some savings to long-term CDs
If you have a lot of savings in a savings account or money market account, consider shifting some of that money into a long-term CD.
Certificates of deposit could offer two benefits in a weakening economy:
- With interest rates already starting to fall due to concern for the economy, CDs can offer you higher rates than short-term savings accounts.
- Also, by allowing you to lock in a rate for a specific period of time, CDs can help shield you from further interest-rate declines.
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3. Review refinancing opportunities now
As interest rates drop, you might find that you could save money by refinancing your mortgage. You might also consider using a personal loan to pay off high-cost-credit-card debt.
Keep in mind that the reason interest rates are falling is because there is concern about a possible recession. So don’t wait too long to take care of refinancing opportunities because, if the economy worsens, lenders might become reluctant to make loans unless you have excellent credit.
4. Minimize borrowing
Refinancing might make sense if lower interest rates could save you money in the long run, but you should shy away from taking on any new debt if you are concerned about a recession.
Even though falling interest rates may make borrowing appear more attractive, the risk is that new borrowing could increase your monthly payments at just the wrong time. Those payments could become increasingly harder to make if your income goes down or money becomes tight due to a recession.
5. Assess your job risk
Unemployment would almost certainly rise during a recession, so your job could be at risk. How big a risk that is depends on your situation. These points can help you determine your best course of action in terms of employment:
- Consider the financial health of your companyAre you in a business that might be especially sensitive to a recession such as one that sells big-ticket consumer products?
- Consider the job market in your area
Unemployment has fallen steadily during the past several years, but some job markets have remained persistently weak. If your local job market was only so-so during a long economic expansion, you might find it especially hard to find a new job during a recession.
- Consider your own job performanceHave you been receiving above-average performance assessments, or might you be one of the first employees to be let go in a recession?
- Consider ways to keep your job skills up to date and competitiveThe more you value can add to your employer, the safer your job could be in a recession.
6. Develop potential side hustles
If you are concerned about job security, start looking into part-time freelance gigs you might be able to take on. These can supplement your income or help tide you over during a period between full-time jobs.
Consider trying these out even before you run into job issues. It can give you a taste for what type of side job suits you, put you in touch with new groups of people and opportunities, and allow you to ramp up more quickly if it turns out you need to rely on one of these extra gigs for income.
7. Review your retirement savings plan
The lower interest rates and weak stock market that often come with a recession can make saving for retirement more difficult.
Review your retirement-planning assumptions now to make sure they are still realistic if low rates and a weak stock market take their toll. You may have to shoot for higher plan contributions in the future to make up for the harm done by a recession.
8. Rebalance investments
The stock market has been strong recently. If rising stock prices have raised the percentage of your investment portfolio that is in stocks, now might be a good time to rein that stock exposure back in.
You should not try to outguess the market by selling off too many stocks out of fear of a recession. However, periodic rebalancing to your target asset allocation can be a good way to smooth out the ups and downs of the market.
Even if a recession doesn’t come in the near future, going through your recession-prep checklist is a valuable exercise. It can strengthen your financial position in preparation for whatever the economy dishes out, good or bad.