In a sluggish economy, or outright recession, it is best to watch your spending and not take undue risks that could put your financial goals in jeopardy. Below are some of the financial risks everyone should avoid taking during a recession.
Becoming a Cosigner
Cosigning a loan can be a very risky thing to do even in flush economic times. If the individual taking the loan does not make the scheduled payments, the cosigner could be asked to make them instead. During an economic downturn, the risks associated with cosigning a note are even greater, since the person taking out the loan has a higher chance of losing their job—not to mention the cosigner's own elevated risk of ending up unemployed.
That said, you may find it necessary to cosign for a family member or close friend regardless of what is happening in the economy. In such cases, it pays to have some money set aside as a cushion. (See also, "8 Ways to Help Family Members in Financial Trouble.")
Taking out an Adjustable-Rate Mortgage
When purchasing a home, you may choose to take out an adjustable rate mortgage (ARM). In some cases, this move makes sense (as long as interest rates are low, the monthly payment will stay low as well).
But consider the worst-case scenario: you lose your job, and interest rates rise as the recession starts to abate. Your monthly payments could go up, making it extremely difficult to keep up with the payments. Late payments and non-payment can in turn have an adverse impact on your credit rating, making it more difficult to obtain a loan in the future.
Taking on Debt
Taking on new debt—such as a car loan, home loan, or student debt—need not be a problem in good times when you can make enough money to cover monthly payments and still save for retirement. But when the economy takes a turn for the worse, risks increase, including the risk that you will be laid off. If that happens, you may have to take a job—or jobs—that pay less than your previous salary, which could eat into your savings.
In short, if you are considering adding debt to your financial equation, understand that this could complicate your financial situation if you are laid off or have your income cut for some reason. Taking on new debt in a recessionary environment is risky and should be approached with caution. In the worst-case scenario, it could even contribute to bankruptcy.
Taking Your Job for Granted
During an economic slowdown, it is important to understand that even large corporations can come under financial pressure, leading them to reduce expenses any way they can. That could mean scaling back the holiday party, cutting the dividend, or shedding jobs. (See also, "Layoffs: Know The WARNing Signs.")
Because jobs become so vulnerable during a recession, employees should do all they can to make sure their employer has a favorable opinion of them. Coming to work early, staying late, and doing top-notch work at all times are no guarantee that your job will be safe, but doing those things does increase your chances of staying on the payroll.
Taking Risks With Investments
This tip applies to business owners. While you should always be thinking about the future and investing to grow your business, an economic slowdown may not be the best time to make risky bets.
For example, taking on a new loan to add physical floor space or to increase inventory may sound appealing—particularly since interest rates are likely to be low during a recession. But if business slows down—another side effect of recessions—you may not have enough left over at the end of the month to pay interest and principal on time. (See also, "5 Sectors With Recession-Proof Pay.")
The Bottom Line
There's no need to live a monk's existence during an economic slowdown, but you should pay extra attention to spending and budgeting, and be wary of taking any unnecessary risks. (See also, "Tutorial: Credit and Debt Management.")