There are many everyday habits that the average person can implement to protect themselves from the sting of a recession or even make it so that its effects aren’t felt at all. As the recession hits, these tools can help you get through it in one piece financially.
- Individuals can develop habits that will protect them ahead of time, even if an economic slowdown or recession takes hold.
- In terms of income, having an emergency fund, strong credit, multiple sources of income, and living within your means are all important.
- In terms of investments, individuals need to think long term and diversify holdings, as well as be realistic about how much risk they can handle.
Have an Emergency Fund
If you have plenty of cash lying around in a high-interest, Federal Deposit Insurance Corp. (FDIC)-insured account, not only will your money retain its full value in times of market turmoil, but it also will be extremely liquid, giving you easy access to funds if you lose your job or are forced to take a pay cut.
Also, if you have your own cash, you will be less dependent on borrowing to cover unexpected costs or the loss of a job. Credit availability tends to dry up quickly when a recession hits. Once these things happen, use your emergency fund to cover necessary expenses, but keep your budget tight on discretionary spending in favor of making that emergency fund last and restoring it ASAP.
Live Within Your Means
If you make it a habit to live within your means each and every day during the good times, you are less likely to go into debt when gas or food prices go up and more likely to adjust your spending in other areas to compensate. Debt begets more debt when you can’t pay it off right away—if you think gas prices are high, wait until you’re paying a 29.99% annual percentage rate (APR) on them by fueling up on a credit card.
To take this principle to the next level, if you have a spouse and are a two-income family, see how close you can get to living off of only one spouse’s income. In good times, this tactic will allow you to save incredible amounts of money—how quickly could you pay off your mortgage, or how much earlier could you retire, if you had an extra $40,000 a year to save?
In bad times, if one spouse gets laid off, you’ll be OK because you’ll already be used to living on one income. Adding to your savings will stop temporarily, but your day-to-day frugal spending lifestyle can continue as normal.
Have Additional Income
Even if you have a great full-time job, it’s not a bad idea to have a source of extra income on the side, whether it’s some consulting work or selling collectibles on eBay. With job security so nonexistent these days, more jobs mean more job security. Diversifying your streams of income is at least as important as diversifying your investments.
Once a recession hits, if you lose one stream of income, at least you still have the other one. You may not be making as much money as you were before, but every little bit helps. You may even come out the other end of the recession with a growing new business as the economy turns up.
Invest for the Long Term
So what if a drop in the market brings your investments down 15%? If you don’t sell, you won’t lose anything. The market is cyclical, and in the long run, you’ll have plenty of opportunities to sell high. In fact, if you buy when the market’s down, you might thank yourself later.
That being said, as you near retirement age, you should make sure that you have enough money in liquid, low-risk investments to retire on time and give the stock portion of your portfolio time to recover. Remember, you don’t need all of your retirement money at age 66—just a portion of it. It might be a bear market when you’re 66, but it could be a bull market by the time you’re 70.
Be Real About Risk Tolerance
Yes, investing gurus say that people in certain age brackets should have their portfolios allocated a certain way, but if you can’t sleep at night when your investments are down 15% for the year and the year isn’t even over, then you may need to change your asset allocation. Investments are supposed to provide you with a sense of financial security, not a sense of panic.
But wait—don’t sell anything while the market is down, or you’ll set those paper losses in stone. When market conditions improve is the time to trade in some of your stocks for bonds, or trade in some of your risky small-cap stocks for less volatile blue-chip stocks.
If you have extra cash available and want to adjust your asset allocation while the market is down, you may even be able to profit from infusing money into temporarily low-priced stocks with long-term value. Buy low so that you can sell stocks high later or hold on to them for the long run.
Be careful not to overestimate your risk tolerance, as that will cause you to make poor investment decisions. Even if you’re at an age where you’re “supposed to” have 80% in stocks and 20% in bonds, you’ll never see the returns that investment advisors intend if you sell when the market is down. These asset allocation suggestions are meant for people who can hang on for the ride.
Diversify Your Investments
If you don’t have all of your money in one place, your paper losses should be mitigated, making it less difficult emotionally to ride out the dips in the market. If you own a home and have a savings account, you already have a start: You have some money in real estate and some money in cash.
In particular, try to build a portfolio of investment pairs that aren’t strongly correlated, meaning that when one is up, the other is down, and vice versa (like stocks and bonds). This also means that you should consider asset classes and stocks in businesses that are unrelated to your primary occupation or income stream.
Implementing these financial strategies will not only serve you well during a slowdown—they’ll also serve you well no matter what’s going on in the market.
Keep Your Credit Score High
When credit markets tighten, if anyone is going to get approved for a mortgage, a credit card, or another type of loan, it will be those with excellent credit. Things like paying your bills on time, keeping your oldest credit cards open, and keeping your ratio of debt to available credit low will help keep your credit score high.
When times are tough, maintain communications with your creditors to keep them happy by making arrangements to keep your accounts in good standing. Many lenders and businesses would rather see you continue to be a customer than have to write off your account as bad debt.
What is a Recession?
A recession means a significant decline in general economic activity. The macroeconomic term has traditionally been recognized as two consecutive quarters of decline, as reflected by gross domestic product (GDP) and other indicators such as unemployment. However, the National Bureau of Economic Research (NBER) currently defines a recession as a significant decline in economic activity lasting more than a few months—normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
How Can I Prepare Financially for a Recession?
There are many everyday habits that you can implement to protect yourself ahead of time from the sting of a potential economic downturn or recession. Having an emergency fund, strong credit, multiple sources of income, and living within your means are all important tools that can help you get through a rough patch in the economy in one piece financially.
How Can I Make My Investment Portfolio More Resistant to a Recession?
In terms of investments, being prepared for a recession involves taking a long-term approach to your investment goals, diversifying your holdings, and remaining realistic about your risk tolerance.
The Bottom Line
The key to riding out a recession starts with planning ahead for the worst case scenario. Build up your emergency fund, pay off your high interest debt, do what you can to live within your means, diversify your investments, invest for the long term, be honest with yourself about your risk tolerance, and keep an eye on your credit score. Once a recession does hit, it's smart to look for a side gig to keep money coming in.