Your Recession Preparation Guide
When the headlines are filled with words like “inflation,” “economic downturn,” and “fears of recession,” it’s easy to get nervous. News of potential job layoffs and a weakening economy may sound scary, but don’t panic—a recession is simply part of the economic cycle, and with some planning and a little tightening of your financial belt, you can weather the storm.
What Exactly is a Recession?
To understand a recession, we need to back up a moment and look at the broader economic cycle. The economic cycle is generally defined as periods of expansion and contraction. It starts with a period of strong Gross Domestic Product (GDP) growth where production is high and interest rates tend to be low.
After the cycle peaks, economic contraction starts, bringing lower employment rates. Often this is accompanied by a saturated market which further pushes prices down. Eventually the economy balances out, and another period of growth and expansion begins, in an unending loop.
A true recession is generally characterized by a decline in GDP for two or more consecutive quarters, along with rising unemployment rates and decreased consumer spending. The effects it can have on individuals can be dire, including job insecurity or even job loss. A general sense of financial unease pervades, as investments decline, and assets lose value.
Signs and Causes of a Recession
The signs of an impending recession aren’t always clear, but there are some economic indicators that can suggest a recession is on the way. Understanding the symptoms of an impending downturn can serve as an early warning system, giving you a head start on preparations.
Be on the lookout for signs like:
- a slowdown in the job market, meaning higher unemployment rates and fewer new jobs.
- a decrease in consumer spending, as people start pinching pennies in response to job insecurity or increased prices at the grocery store.
- an inverted yield curve, which is when short-term interest rates are higher than long-term rates.
All these indicators, particularly when they show up together, can signal an impending economic slowdown.
Building Your Financial Fortress
When it comes to preparing your finances for a recession, you need to take a proactive approach. The basics include building an emergency fund, reducing debt, spending wisely, following a budget, and exploring multiple income streams. Addressing each area will allow you to take charge of your financial future.
The Emergency Fund Safety Net
An emergency savings fund is acts as a crucial safety net at any time, but it’s especially important during a recession. Ideally, an emergency fund should cover at least 3-6 months of living expenses, but even a fund of $1,000 could be the difference between survival and falling into a cycle of debt.
Your emergency fund should be somewhere accessible, but ideally also somewhere it can earn you interest until you need it. Consider a high-yield savings account, and continue contributing to it as you are able.
Lighten the Load by Reducing Debt
Paying down debt is an excellent goal, but it becomes especially important during periods of economic downturn. Reducing your debt—especially high-interest debt—frees up additional income each month, offering you some financial breathing room.
Prioritize your highest-interest debt first, as it’s costing you the most in the long run, then focus on paying down the rest. It’ll be one less pain point when the economy tightens its belt.
Spend Wisely
An important tip at any time is to establish and draw the line between needs and wants, and this becomes especially important during a recession. Differentiate your expenses by essential items like housing, food, and transportation and separate out those non-essentials like entertainment and dining out. While splurging occasionally probably won’t break the bank, it can become a costly habit when times are tough.
You may also want to consider delaying any new debt or luxury expenses whenever possible. Overextending yourself on a new car loan might not get you into too much trouble when the economy is strong, but during a recession it can be downright risky. You can’t always count on a raise at work or low interest rates to boost your spending power during an economic downturn.
Budgeting and Cost-Cutting
A solid budget is the bedrock of financial planning. A budget is not meant to be a constraint, but rather a tool to raise your financial awareness.
Knowing how much money you have coming in and how much is going back out can help you reconsider your priorities. It can also show you where expenses can be trimmed when necessary. This might include cutting back on subscriptions, eating out less, or finding cheaper alternatives for everyday needs, like carpooling to work.
Multiple Income Streams
In a perfect world, your job would be guaranteed, and you could continue to count on it during a recession. Unfortunately, the recession affects everyone, and the reality is that some people will likely lose their primary source of income when the economy contracts.
Side hustles and passive income channels not only boost your bank account, but also provide a cushion against potential job market volatility. Explore opportunities in the gig economy or turn hobbies into money-makers to help keep your income streams robust.
Staying Positive and Looking Ahead
It’s important to remember that recessions, though challenging, are temporary. It's easy to be overwhelmed by the forecasts of economic doom but try to keep a positive outlook: Recession is a phase, not a permanent state of being. Instead of focusing on the negatives, look to the future with a strategic approach.
Economic prospects may not look great during a recession, but as history has demonstrated repeatedly, a period of growth is just around the corner. And while you may not be able to influence the macroeconomic factors that lead to a recession, there are many aspects of your personal finances that you can control. By concentrating on these, you can minimize the impact of recession on your life.
Your Recession-Ready Toolkit
While the prospect of a recession might be anxiety-provoking, the important thing to remember with a recession is that with some preparation, it’s possible to not only survive, but even thrive. Preparing for a recession is simpler than it seems, and it looks a lot like managing your finances well at any time.
By taking control of your finances now, you’ll be ready the next time a recession rolls around. With an established emergency fund, debt reduction, controlled spending, effective budgeting, and diverse income streams, you can both safeguard your wealth and emerge stronger when the recession passes.
Take action now to organize your finances, so you can face the future with confidence, whatever the economy brings.