Are your personal finances ready to weather a recession? If not, it may be a good idea to start preparing.
While this may seem like an impossible task, we’re here to tell you it’s possible to start recession proofing your finances. Our guide touches on key ideas and answers some important questions, including what is a personal line of credit’s role in all this and how much an emergency fund should be.
No matter what happens, try to keep calm and follow the tips below. Here are our recommendations on how to prepare for the next recession.
What is a Recession?
A recession is a complicated thing, so we turn to the experts at the National Bureau of Economic Research (NBER), a non-profit organization dedicated to conducting economic research in the United States. It’s the official arbiter of economic peaks and troughs, so they know what they’re talking about.
The NBER defines a recession as the following:
“…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”[1].
What Does a Recession Mean for You?
Now with the official textbook definition out of the way, let’s focus on what happens during a recession and the real-world effects that directly impact you.
A recession sets off a chain reaction in the economy.
As retail sales and production levels drop, people may lose their jobs. Without a stable income, many people can’t buy as much or as often as they used to. They may struggle to pay their regular bills, or even rent.
A nation without expendable cash delivers a second blow to the markets. Demand plummets when fewer people buy things, so, many businesses end up closing and laying off more people – putting many people into further financial emergency.
How to Prepare for a Recession
The effects of a recession vary greatly. Some people barely feel the crunch, while others are significantly affected during the economic downturn.
Your experience may depend on what industry you work in. Some essential workers are bound to keep their jobs while certain retail workers may be the first to be laid off.
It also has to do with the state of your finances before a recession hits. If you’re struggling to pay bills now, it may not get any easier unless you change your financial habits.
Let’s take a look at some techniques that may help your financial situation during a recession.
1. Create an Emergency Fund
An emergency fund is a specialized savings account that you pack with money and can access when things go wrong. Whether it’s an unexpected auto repair or an unforeseen medical expense, an emergency fund will act as your financial safety net through trying times.
Depending on its size, it may also help you weather a more serious recession.
This being said, how much should an emergency fund be? That is, how much money should you save in your emergency fund? The answer to this question is relative and there is no actual number set in stone. The golden rule of emergency funds is saving anywhere between three to six months’ worth of expenses in this fund. But not all financial advisors agree. Some, like David Bach[1] and Suze Orman[2] suggest upping your fund to cover as much as one years’ worth of expenses to be your financial safety net, though this obviously may not be realistic for everybody.
Whether you opt for three, six or twelve months is up to you and your finances. Consider your risk tolerance, then decide on whatever goal makes you feel the most financially secure and recession proof while preparing for another economic downturn.
Are you on track?
If you’re far from saving what you need to survive a financial emergency, you’re not alone. To kickstart your emergency fund into gear, sit down with your budget so you can stow away some cash with each paycheck.
The 50-30-20 Budget recommends saving as much as 20 percent of your income after taxes. This amount acts, in part, as your very own emergency financial assistance through emergency fund contributions, but also works towards your debt payments and future goals.
2. Trim the Fat
Spending more than you earn is never a good idea, but it’s especially irrational during a recession.
When a recession hits, lean and mean is the motto for your budget. You’ll want to strip your spending down to the bare essentials that you have to pay and buy.
Cutting back on your expenses is a good idea while you’re preparing for a recession, too. It helps you meet your savings target, freeing up more cash at hand to help bulk up your personal financial safety net.
What Stays and What Goes?
If you aren’t sure how to scale back to create a more recession proof course of action, sit down with your budget, and separate your spending into two major categories: needs and wants.
Needs: These expenses cover the essentials, like housing, healthcare, utilities, and groceries. If you genuinely can’t live without it safely, it’s likely a need.
Wants: Wants, or discretionary spending, cover all the fun things in life, like concerts, getaway trips, subscription services, and takeout. While you might miss them, you don’t need them to live.
Your wants are the easiest things to cut back on, so focus on those first. Try cutting them in half or eliminating them entirely to free up more cash. Though it may sound harsh and extremely difficult, doing so can go a long way to add to your emergency financial assistance fund during the next recession.
3. Pay off Debt
Debt is already a difficult enough burden to carry around in life. But carrying debt during a recession can make an already tough situation even worse and more stressful.
Whether it’s a personal line of credit or unsecured loan — two products featured in our glossary of useful financial terms — these payments eat into your monthly cash flow.
You may be able to afford your personal loan or line of credit or credit card payments now, under normal economic circumstances. However, you may struggle to keep up with them if you lose part or all of your income during a recession.
It may be easier to endure a recession if you don’t have to make payments against your debt. That is why you should always make sure to set aside cash for debt reduction in your budget to ease yourself some stress and financial hardship when dealing with debt during a recession.
4. Boost Your Income
Between your fixed bills, savings, and debt reduction, your paycheck may be stretched thin. If you’re finding it hard to hit your targets while preparing for a recession, consider how you might increase your earnings as it may help to give your finances more breathing room.
Padding out your paycheck isn’t always easy, so here are some ideas to help you increase your earning potential.
- Learn New Skills. Take free classes, earn certificates, and volunteer to increase your skill set. Adding this to your resume may make you qualified for higher-paying jobs, or it may help you negotiate for a raise at your current place of employment.
- Market Your Hobbies. Depending on your hobbies, there might be a market for your skills — whether you’re a baker, candlestick maker, or a keen data analyst. Go online to see if you can find freelance gigs using what you know.
- Get a Second Job. If you have the time, consider applying for a more traditional part-time job you can work during the evenings and weekends.
It may be tempting to celebrate with the cash you earn here but keep in mind that putting the funds you earn towards an emergency fund or financial safety net should be priority when preparing for a recession. Split any extra cash you earn between savings and paying down your debt, such as line of credit or credit card bills.
5. Monitor Your Credit History
It’s always a good idea to monitor your credit report. This report is a litmus test for your finances. It shows how well you’ve managed a personal loan or line of credit in the past, so it may influence how easily you can borrow money in the future. It is especially important to ensure that you keep this report in good standing as it may be a crucial factor to determine whether you can easily take out an emergency loan in the case of your next financial emergency where your finances will depend on it.
Want to learn more about credit scores and what impacts your credit history? Click here to find out!
People with bad credit may face more challenges when looking for loans, but it may still be possible to apply if you consider short term loans.
A benefit of short-term loans is that they’re designed as a safety net in case you face an unexpected emergency expense when your savings are low.
6. Research Your Investing Options
Good money management requires a long-term view of your financial needs and goals. Beyond building an emergency fund to brace for the next recession, you may be also investing in your child’s education or your retirement in general.
Many long-term investments rely on the stock market, and the stock market tends to plummet during a recession. This is why you should take a serious look at the nature of your investments and how the next recession can affect them, to influence how you go about preparing for a recession. Consider a game plan for yourself if the economy goes sour so that you are not at a crossroads with what to do if the stock market plummets.
With your future on the line, you may be tempted to halt your investments or withdraw them entirely. But think twice about this strategy.
Keep in mind that it may cost money to remove funds early from certain investments. For example, both a 529 College Savings Plan[1] and 401(k)[2] may levy tax penalties if you withdraw before a specific time.
Make sure to do your research to see what works best for your finances.
Don’t Wait, Start Preparing Your Finances Today
No matter what happens, finding out how to prepare for the next recession starts with today. How you manage your finances now will have a huge impact on how they fare when the economy turns.
How are your finances doing? If you’re living beyond your means or ignoring debt, now is the time to break out of these bad habits. Focus on your budget and make a plan to pay down your debt and set aside cash in savings as these resolutions will be your answer on how to survive a recession.
Unfortunately, life, like the stock markets, isn’t always predictable. If your plans go haywire, don’t freak out. Find out more about the services offered through CreditFresh to see how they might be able to help you in an unexpected emergency.
Managing a recession is like sailing on choppy seas. It may be tough, but the more prepared you are, the better you’ll be able to weather this storm.
Disclaimer: This article provides general information only and does not constitute financial, legal or other professional advice. For full details, see CreditFresh’s Terms of Use.
[1] https://www.nber.org/cycles/jan08bcdc_memo.html
[2] https://www.cnbc.com/2018/11/01/david-bach-heres-how-much-money-you-need-in-your-emergency-fund.html
[3] https://www.cnbc.com/2018/06/13/how-much-money-suze-orman-says-to-have-in-your-emergency-fund.html
[4] https://www.cnbc.com/2019/01/23/most-americans-dont-have-the-savings-to-cover-a-1000-emergency.html
[5] https://www.thebalance.com/the-50-30-20-rule-of-thumb-453922
[6] https://www.investopedia.com/ask/answers/101314/how-do-you-withdraw-money-your-401k.asp
[7] https://www.fool.com/knowledge-center/penalty-for-early-withdrawal-from-529-plans.aspx
