Recessions can leave many households feeling the pinch – whether they are affected by job losses or not. However, a little bit of preparation can reduce the impact the recession has on your finances. Let’s take a look at how to prepare for a recession.
What Is a Recession
A recession is significant reduced economic activity for a period of at least 6 months. The average duration of recent recessions in the US is 10 months, with the longest recent recession lasting 18 months. The longest recession in US history was significantly longer, lasting 5 years.
In recent years, we have seen layoffs and reduced profit in single industries, but those are not considered to be a recession. For an economic downturn to be classed as a recession, it must affect the economy as a whole rather than just one industry. America has experienced 4 recessions in the last 30 years – the most recent being the Covid-19 recession of 2020.
What Happens During a Recession?
During a recession, businesses either experience lower sales or higher operating costs. Due to this, the prices of goods and services will increase, and production may decrease as businesses attempt to reduce their operating costs. Businesses will usually implement a hiring freeze during a recession to reduce their costs. They will also often lay off their employees or reduce hours/wages if they believe they cannot cut costs enough in other areas. Benefits or perks may also be put on hold temporarily during the recession.
These measures will affect individuals because not only are the costs of goods higher, but people are also likely to experience job loss, reduced hours or wages, or job uncertainty. The job market is competitive during a recession, with more people looking for work and fewer companies hiring.
Recessions also often affect investments and savings across the board. Stocks lose value during a recession and may even temporarily halt paying dividends. Real estate will often also lose value during a recession, and it may be more difficult to secure a mortgage. Lenders often implement stricter requirements during a recession, so it is more difficult to secure any kind of credit.
When there is a recession, you are likely to feel the effects of it in some shape or form. However, there are a few things you can do to prepare for a recession so you can reduce the financial impact.
How to Prepare for a Recession
Recessions are a normal part of the economic cycle, so it is not a matter of if you will experience a recession; it is a matter of when. In the US, there have been 4 recessions in the last 30 years. There are some simple things you can do to prepare for a recession. Doing these things to prepare for a recession does not mean that you will not be affected by the recession at all; it will simply reduce the impact of the economic downturn.
1. Review Your Financial Situation
Understanding your finances helps you to prepare for a recession because you are armed with the knowledge of how long your finances will allow you to survive without income. This can take some of the stress out of losing your job or experiencing financial stress during a recession because you know where you stand.
Answer the following questions:
- What is the total value of my assets?
- What is the total value of my debts?
- How much money do I have access to if I need it (without needing to sell things or liquidate assets.)
- How much are my debt repayments?
- What are my essential living expenses?
- What are my non-essential expenses where I am locked into repayments?
- What are my significant upcoming expenses?
Once you understand your financial situation, it will help you to know what you need to do to prepare for a recession. You can determine what your basic monthly living costs are and how many months your savings will last.
Ideally, you would have an emergency fund. An emergency fund is a savings account that you can access quickly during an emergency. Your emergency fund should have enough money to cover 3-6 months of your basic living expenses. If you don’t have an emergency fund of that size, that should be your financial goal. Your emergency fund is the first step to prepare for a recession. It will ensure you can cover your bills if you lose your job and give you time to find a suitable job (rather than taking the first job that comes along).
In order to save an emergency fund or prepare for a recession in general, you may need to tighten your budget temporarily. It is a great opportunity to review your budget and see if there is anything you want to cut from your budget. You may have subscriptions you forgot to cancel or things that you no longer want to spend money on.
2. Repay Debts
Once you have an emergency fund of 3-6 months, the next step to prepare for a recession is to repay your debts. Paying down your debts lowers your monthly essential expenses and improves your credit history.
You should also take stock of your debts and figure out which ones are the highest priority if you ever need to choose which debts you can afford to pay off. Priority can be determined by a number of factors, like the importance of the bill or the interest rate. Here is a sample of how to prioritize:
- Mortgage or rent – This is the most important bill because it keeps the roof over your head. Failing to pay this bill may lead to eviction.
- Car payment – This is dependent on whether you need a car for work or not.
- Credit cards and other high-interest loans – Credit cards are likely to have the highest interest rates of all your loans. Prioritize repaying this loan when you have spare money and ensure you have enough money to at least make the minimum repayments.
After that, you should consider the impact and interest rate of your other debts. Would not repaying the loan affect your life in a major way? Would not repaying the loan significantly increase the loan amount?
Another way to prepare for a recession is to look into what options are available to you if you cannot pay your loans temporarily. Some of your loans may have hardship schemes that allow you to pause the loan or give you a non-repayment period without financial penalties. Some may even allow a repayment plan. This goes for your bills, too; some utilities, rent, or mortgages will have assistance programs, especially during a recession.
3. Look at Your Career Options
Consider your short and long-term career options. This includes advancement in your current career path plus what your backup plan is.
A great way to prepare for a recession is to improve your job prospects. Some ideas you can try include:
- Strengthening your professional connections – Your professional network can help you throughout your career, particularly when searching for jobs. Your professional connections might be able to let you know about job opportunities or put a good word in for you. Start with your current colleagues and then extend your network outside your current employer. Focus on quality rather than quantity of professional relationships.
- Update your resume – Keep a note of your professional accomplishments to make it easy to update your resume when you need it. Especially if you lose your job, it can be overwhelming to have to update your resume and cover letter. Having a list of your accomplishments, skills, and professional qualifications is a great way to prepare for a recession because it can make it easy to tailor your resume for new jobs. All you need to do is assemble the information.
- Improve your employability – Prepare for a recession by boosting how you look on paper. This may include gaining new accreditations or increasing your skills and experience through working on new projects in your current role. When you are updating your resume, you may even notice it is time to look for a promotion because you have been in your current role for a while.
- Start an extra income stream – Having an extra stream of income will help you to prepare for a recession by reducing the financial impact if you lose your job. Depending on how you earn the extra income, it might even be a great way to increase your skills or open up a new career path. Your extra income can help you prepare for a recession by helping you build an emergency fund or pay down debts faster.
4. Increase Your Emergency Fund
A 3-6 emergency fund is the minimum amount you need to be financially stable. You can prepare for a recession further by increasing your emergency fund even more. Remember, the average recession in the US has lasted for 10 months, and the impact may last longer than that. Increasing your emergency fund can give you the extra security you need to find a new job in your chosen field. You won’t need to find a job to tide you over so you can pay your bills.
Look at your expenses and life situation to decide what your ideal emergency fund is. For example, if you are a single-income household, you may feel more financially secure with a larger emergency fund. A large emergency fund may also help you prepare for a recession if you have kids or large fixed expenses, like a mortgage.
Exploring 14 recession-proof industries could offer additional job security and financial stability during economic downturns.
5. Regularly Review Your Financial Situation
Financial reviews shouldn’t be a one-time thing. Regularly reviewing your finances doesn’t just prepare for a recession; it will help you understand where your money is going and achieve your financial goals.
During your financial reviews, look at your financial goals and what progress you are making towards them. This allows you to identify if you need to increase savings or decrease expenses while it’s still early enough that it won’t derail your goals.
Regular financial reviews are a great way to spot areas where you need more financial education. It is important to understand the financial decisions you are making and their short-term and long-term impact on your future. This is true both when preparing for a recession and in general.
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