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Recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.
During a recession, businesses struggle to make profits, leading to layoffs and job losses. Unemployment rates tend to rise significantly during a recession. Reduced consumer spending: Consumers tend to reduce spending during a recession as they become more cautious with their money.
Hearing the word recession creates a feeling of discomfort for many. After all, recessions come with a lot of negatives, like stock market declines, job losses, and more. But you can learn how to prepare for a recession and still thrive financially.
Preparing for a recession is essential to your financial security. It’s essential for you to know how to prepare for a recession, as it can impact your career, lifestyle, and finances. Knowing how it affects the economy and your finances and taking key steps will help you during an economic downturn. Let’s get into what it all means and how you can prepare for a recession.
What happens during a recession?
Recessions can be damaging to stocks and assets, causing them to lose value. A recession could also cause interest rates to drop. The Federal Reserve may decide to cut rates to make it cheaper to get loans and borrow money in an effort to try to stimulate the economy.
In addition, this means you will see rates drop on your savings accounts too.
The government debt may rise as they pass bills for stimulus packages to assist those in need. And also to help the economy recover.
Now you can still invest during a recession. In fact, if you’re wondering is now a good time to invest, it can be if you do it right.
How to prepare for a recession financially
Here are ten key tips for how to prepare for a recession.
- Assess your overall finances
Before you start to make a plan for a recession, consider what your finances look like right now.
For example, what are you currently paying for in your monthly expenses list? You likely have some necessary expenses, such as your mortgage or childcare.
But are there things that you really don’t need or can afford to cut back on?
For instance, dry cleaning, hair and nail salon appointments, restaurants, etc. Perhaps you’re spending too much on non-essential things and living a champagne lifestyle that you can’t afford.
In that case, cut back for the time being so you can use your money and focus on more essential matters and needs.
2. Ensure you can cover your basics before you invest or pay debt
If you can’t afford your current lifestyle, or you are struggling to pay your bills without debt each month, it’s time to make some changes.
Before using your money for investing or paying off debt, be sure that you can pay for all of your basic necessary expenses. Rent, groceries, insurance, etc., are all things to pay for before doing anything else with your money.
If you need to make more income to afford your basic bills, consider a side hustle or a second job. Then you can change your focus to paying off debt, investing, building an emergency fund, etc. Doing so can help you in your future by preparing you for a recession.
3. Bulk up your emergency savings and keep it easily accessible
As you work on getting your finances ready for a recession, it’s very important to have emergency savings in place. In a recession, having an emergency fund can save you a lot of stress. It acts as a safety net with enough money to help you during difficult times.
You’ll avoid becoming financially over-extended or having to leverage debt just to get by. The importance of savings cannot be overlooked!
Save 3 to 12 months of expenses
To start, you want to put aside 3 to 6 months’ worth of your basic living expenses in an emergency account in the unfortunate event that you become unemployed.
And since recessions can be pretty unpredictable, aim to boost your emergency savings to 12 months of your essential expenses to have extra money if needed.
That much cash will give you ample time to find a new job. But remember, jobs can be harder to come by in an economy experiencing a recession.
Keep in mind that your basic living expenses are the essential things you need to survive; food, housing, core utilities, and transportation. Building your emergency fund is one of the most important steps when preparing for a recession.
4. Diversify your investments
Ever heard the saying, don’t put all your eggs in one basket? Well, the same line of thinking applies to your investments.
It’s important to have a well-diversified investment portfolio, such as a 3 fund portfolio. That means your investments should not all be tied up in one stock or one real estate property.
You want to make sure your investments are spread across multiple industries and areas so that if one industry or area experiences a decline, one investment decision doesn’t sink your entire portfolio.
For example, if you invest in the stock market, you can spread your investments across multiple sectors such as consumer goods, healthcare, technology, etc.
Investing with index funds and mutual funds are both great ways to diversify. You can also choose to invest in the real estate market and in small businesses.
How to invest wisely
As an investor, be sure to do your research, be clear on your investment strategy and objectives, and understand how risk averse you are. It will create less panic for you if a recession comes along.
A big mistake people make is that they start selling every investment they own when the economy dips because of emotions like fear or worry. It’s a bad idea in the long run.
If you have a clear plan for your investments and you’re in it for the long term, you are in a good place. Your investment is likely to weather a bad economy and come out on top.
Talk to a financial advisor if you have any confusion or feel stuck regarding what to do. (Find out: do I need a financial advisor?) Prepare for a recession by diversifying your investments wisely.
5. Create a plan to pay off debt once your essentials are covered
The last thing you want to do is worry about having to pay off debt in a bad economy, especially with the increased rates of unemployment. When focusing on how to prepare for a recession, debt payoff should definitely be a factor.
Paying off your debt will save you a ton of money in interest payments and put you in a better financial situation. Plus, you’ll also be able to put your extra funds toward bulking up your emergency savings and other financial goals.
So, after your basic expenses are covered, as discussed earlier, you can start using your excess income to pay off debt or save.
Prioritize high-interest debt
It’s a good idea to focus on paying off your high-interest debt before you consider ramping up on investing (meaning investing more than your usual amount, though you should always invest some if you’re able to).
If you have high-interest debt the cost of your interest payments may far exceed the return on your investment.
For instance, if you have credit card debt that has a 19% interest rate, then it makes more sense to pay off that debt as soon as you can, given that the average long-term rate of return on the stock market is ~8% to 10%. Reduce credit card debt if at all possible.
Obviously, your rate of return could be much higher, but you want to avoid speculating or trying to time the market.
Once your debt is gone, you can focus on investing a higher percentage. If you have no other debt and your investments are on track, you might consider paying extra toward your mortgage to pay off that debt, too.
6. Learn how to budget and live within your means
Living below your means or at least within your means is the key to building wealth. It also means you eliminate having to leverage debt to live your life – no more using credit cards to pay your bills.
Find out how to prepare for a recession and still live within your means.
Use your budget to focus on financial security
Determine what budgeting style works best for you and learn better budgeting techniques. Your budget will help you track your expenses compare what you earn and highlight areas you can cut back on.
Your ultimate goal should be to widen the gap between your income and expenses as much as you can. You do this by finding out how to increase your income and reduce your expenses. Spend on necessities instead of luxuries, as discussed earlier.
Any leftover money can be used to create financial security, which can primarily be achieved through saving, investing, paying off debt, and making your money work for you.
Make a plan about how much you want to save, what other income sources you can create, and how you’ll pay off debt. Then give all your attention and any spare money to those goals.
When you make progress towards your financial goals, refuse to upgrade your lifestyle. There will be time for that when you are in a better financial situation, but if you’re focused on preparing for a recession, then don’t spend on things you don’t need for now.
Continue with your plan, and you will be in a much better place with your money.
7. Refinance variable interest debt into fixed interest
Interest rates typically decline during a recession. That means you may be in a good position to refinance things like your mortgages.
Having a variable interest rate means that it can change over time, so getting a fixed interest rate for any debt you have is usually ideal.
Remember, refinancing only applies to the debt you already have.
A recession may not be a great time to take on new debt unless it’s necessary and you’re absolutely sure you can afford it. Always have a payoff plan, no matter what.
8. Find more ways to create multiple streams of income
Millionaires usually have several income sources, and for good reason. Creating multiple sources of income ensures that you increase how much you have coming in, and it can increase your peace of mind during economic uncertainty.
It also acts as a buffer in case you lose a source of income. Here’s how to get started with making more money.
Start a side hustle
Is there something you’re passionate about doing? Something you do that you get complimented on all the time?
Consider starting a side hustle to generate some additional income. There are also a variety of recession-proof businesses you can consider.
Side hustling can help you build up your savings, pay off debt, and just be generally more prepared for difficult financial circumstances.
Consider passive income opportunities
Setting up passive income sources is also a smart idea. Passive real estate investing like REITs (Real Estate Investment Trusts), royalties, and selling digital products like eBooks can all be sources of passive income that can help you in tough times.
Dividend investing can also be a passive income source, as can becoming a landlord. There are many opportunities, so as you consider the resources you have, find out which ones will work for you.
9. Dual income household? Learn to live on one income and save the other
One of the savviest financial moves you can make to prepare for a recession is to shift to living on one income and saving the other. Getting frugal with your budget and reducing expenses can free up a lot of money to save for a rainy day fund.
The goal is to reduce your cost of living enough to free up the second salary altogether.
You will build up your emergency fund and not rely on a second income in the event of a job loss. Living below your means is the best way to prepare for the unexpected.
10. Consider finding a recession-proof job if you are in the job market
Another way to prepare for a recession as an employee is to consider recession-proof jobs. Healthcare workers, teachers, and pharmacists are types of jobs in demand even during a recession.
If you aren’t looking for a job, it’s still important to be prepared. Expanding your skills is excellent for job security, especially when it comes to wages and working remotely.
Make sure to add any new skills to your resume to stay prepared in case someone is hiring for a job you’re interested in.
Another idea for jobs is remote work. Companies are shifting towards remote positions now more than ever. Since the best work from home jobs are on the rise, you might consider applying for some or starting a home-based business.
Recessions are going to happen, so it’s important to always know how to prepare for a recession. Your best bet is to take the approach of being over prepared.
During recession, You should buy things that are likely to be cheaper and make the most sense financially for example your core essentials. It’s a good time to invest, especially in stocks and potentially real estate.
Make the investments that you can afford after you pay your bills, of course.
Beyond investing, what you buy during a recession really depends on your goals and financial obligations. If you have savings and are doing well financially during a recession, you may be able to spend as normal.
Also, consider careers and money-making opportunities that thrive in a recession, like healthcare, grocery stores, etc.
In addition to this, continue to make money as usual by not quitting your day job, if possible. One of the best ideas for maximum financial security during a recession is to have a full-time job and a side hustle. The more hours you can work, the more prepared you are and the more financial wellness you have.