If you’re anxious about a recession, you can do several things to be prepared.
While nobody can predict exactly when a recession may hit, you can develop smart financial habits to protect yourself ahead of time from the effects of an economic downturn. We’ll look at what a recession is and offer some strategies to help you safeguard your financial well-being.
What is a Recession?
Let’s start with the basics. A recession means a significant decline in general economic activity. This term has traditionally been used to describe two consecutive quarters of decline of gross domestic product (GDP) as well in other factors such as unemployment numbers. GDP is the total value of all final goods and services our country produces and sells.
You don’t need to sit on the sidelines and worry about a coming recession. You can jump in and take action to relieve your financial anxiety and protect yourself from a downturn. As you prepare, you’ll want to focus on reducing spending, paying down your credit card debt, adding extra sources of income, and pumping up your emergency savings. You’ll also want to keep investing if you’re able to.
- Reduce Spending
With a recession on the horizon, focus on reducing your spending first. Take a close look at your budget and figure out where your money’s going. Then think of ways – big and small – you can cut expenses.
Maybe you can dine out less often, skip a vacation, get rid of cable TV, or raise the deductible on your home or auto insurance. Think about putting off buying a new car or making non-essential upgrades to your home. To prepare for a recession, it’s better to put money in your pocket rather than take on new debt.
Living within your means is a good habit to adopt – during good times and bad – and the discipline you develop can help you prioritize saving over spending.
- Increase Cash Flow
A little extra cash flow is never a bad idea, whether it’s freelancing, consulting, or selling crafts or collectibles online through eBay. If your income gets reduced during a recession, you’ll already have another source of money to get you through lean times.
If you’re looking to beef up your paycheck, you might want to find a higher-paying job. Just remember that it could be risky being a relatively new employee at a company when the economy sours. Think carefully and be sure that a job change is the best move.
What else can you do to boost your income? While it’s generally considered a last-resort option, some experts advocate reducing the contributions you're making to a retirement or investment account for a few months and putting the money in a money market account.
- Tackle Credit Card Debt
While saving money is a smart budgeting move, so is paying down or paying off your credit cards, especially those with high interest rates. If your income is dinged during a recession, making payments can be difficult, so it’s a wise move to be proactive and funnel as much money as you can into reducing your debt ahead of time.
You may want to look into zero-rate balance transfers or a fixed-rate personal loan to whittle down your balance. If you’re getting a tax refund, think about putting part of it toward paying off your cards.
You can also try an accelerated debt payoff strategy such as the avalanche method or the snowball method.
With the avalanche method, you make minimum payments on all your accounts and then put as much extra money as possible toward the account with the highest interest rate. With the snowball method, you focus on the debt with the lowest balance, regardless of the interest rate. Once that’s paid off, you move to the account with the next lowest balance and use the same approach.
There are pros and cons to each method. Using the avalanche method will save you the most money on interest payments, but it can take a long time to pay off the first debt. If you pick the snowball method, you’ll reduce the total number of debts faster, but you’ll incur more interest charges. That said, many people prefer the snowball method as it helps them stay motivated as they watch debts disappear.
- Boost Your Emergency Savings
As we all know, an unexpected event or bill can negatively impact your household finances. To prepare for these events, experts generally recommend socking away enough cash to cover three to six months of expenses. During an economic slowdown, you’ll want to shoot for saving more – enough to cover six months to a year of necessary expenses.
The upside to having cash on hand means that you won’t have to borrow to cover unexpected costs or a pay cut or job loss. Once the economy improves, keep your discretionary spending low and replenish your emergency fund so you’re always prepared for whatever life brings your way.
- Keep Investing if You Can
If you look at your retirement account balance and your investment portfolio and see them dropping, it’s understandable that you might be concerned. But experts advise against doing something rash that you could later regret. While markets go down, they eventually go back up again, so it’s recommended to stick with your investment plan and focus on long-term goals.
One thing you can do is review your portfolio’s asset allocation. The mix you chose and haven’t looked at for years might not reflect the stage of life – or the appetite for risk – you’re experiencing now, especially with potential recession looming. As you look at current or potential investments, make sure you’re comfortable with the mix and the level of risk involved. You can adjust your portfolio so that it suits your current needs.
Adjusting your portfolio is especially important if you’re nearing retirement age. Experts recommend having enough money in liquid, low-risk investments to retire on time. You won’t need all your retirement money when you hit 65, just some of it. Holding onto the stock portion of your portfolio can give it time to recover when markets inevitably rise.
Diversification is a smart investment strategy, and you should try to build a portfolio with a good mix of stocks and bonds, so that if one is down another might be up.
Home Equity Line of Credit
So, you’ve reduced spending, looked into creating additional cash flow, paid down your credit cards, put money away for emergencies, and are investing when and where you can. What else can you do to protect your yourself from an economic downturn?
During a recession, lines of credit can be harder to get. That said, if you own a home, a home equity line of credit (HELOC) can be a smart choice as a backup source of funds. The good news is you can be approved for a HELOC without actually borrowing any money. If you have good credit, most lenders will let you borrow up to 90% of the equity you have in your home.
How does a HELOC work? A HELOC has a variable interest rate and is more like a credit card with an expiration date – generally five to 10 years after you establish the line of credit. Because you’re using your home as collateral, HELOCs typically have lower interest rates than other lines of credit, but they also tend to have higher monthly payments. If you’re not able to make the minimum monthly payments, you run the risk of losing your house – so make sure that using a HELOC is the right financial decision for your situation.
Recessions, however unpleasant, are a natural part of the economic cycle, but being prepared for a downturn can help you ride it out. If you have questions or need help planning your finances or building savings, reach out to your financial institution.