Written by: Gilles Hudelot, Director of Education
Unless you have a few years’ worth of expenses stored away somewhere, your financial plan will never be 100% recession-proof. However, this does not mean that you should just wait and hope for the best. There are ways to prepare and hedge yourself against potential windfalls in the years or even months leading up to a recession.
Sometimes recessions come on unexpectedly, and sometimes financial experts warn of impending recessions well in advance. Either way, recessions are normal and are bound to happen at least once or twice in your lifetime. Consequently, you should prioritize learning how to prepare for a recession as soon as possible.
The Current Economic Climate
As of this writing, the United States is not experiencing a recession. However, even economists cannot always pinpoint exactly when a recession begins, as it is measured using various factors contributing to the larger economy. For this reason, understanding the relevant terminology is extremely important.
Market corrections, bear markets, and recessions are often used interchangeably, despite the fact that they have very different meanings. A market correction is a 10% drop from the market peak, while a bear market is a 20% drop that lasts over two months. Alternatively, a recession is a drop in the broader economic output, measured by things like the GDP. For example, if the GDP drops for two consecutive quarters, then it will likely be defined as a recession.
The economy can experience a market correction without descending into a bear market. Similarly, a recession can happen without the occurrence of a bear market, though the two often go hand-in-hand. That said, it is not uncommon for the stock market to be negatively affected by the onset of a recession (or even pre-recession indicators). Therefore, recessions and market volatility can often put an even greater financial strain on individuals and businesses.
How to Prepare for a Recession
At Mentoro, our financial mentors always return to the fundamentals of financial health when advising others before, during, or even after a recession. First and foremost, you should be most concerned with and focused on the things you can control. Unfortunately, you cannot control whether or not a recession occurs. However, you can control how you prepare for a recession.
In the event of a recession, some of the biggest concerns are layoffs or sudden reductions in income. For example, if you are self-employed, you may not make as much money as would when the economic outlook is better. Alternatively, if you work for a large company, you may become the victim of cutbacks. After all, businesses have to keep an eye on the bottom line, too. In a recession, many companies find themselves overextended and exposed to risk. To stay afloat, they give themselves more cushion by cutting costs and reducing the size of their workforce.
So, what can you do to prepare for potential income reduction or job loss during a recession? In essence, you should do the same thing that many companies do. You should provide yourself with some “cushion.” This cushion usually takes the form of personal savings. We recommend having at least 3-6 months’ worth of savings on hand (i.e. you could still pay all of your bills and live for 3-6 months without an income). In addition to providing a financial safety net, ample savings give you much more time to make level-headed decisions in the event that you need to make career or life changes.
If you have a lot of debt, a recession can be very impactful, especially if you get laid off or you are making less money. You could end up missing payments and hurting your credit score. For this reason, you should try to save up as much as you can before and during a recession. Additionally, monitor your spending to find areas where you could cut back on non-essential expenditures and, if possible, put any additional funds toward savings or debt payments.
Using the Benefits of a Recession to Your Advantage
Though it is strange to consider, there can be some benefits of a recession. In many cases, a recession can take some pressure off price hikes. For example, housing cost increases could slow down or even reverse during a recession. Part of the reason the Fed is raising interest rates is so that people will spend and demand less, adjusting the supply and demand back to a manageable level. This also brings prices back down.
Moreover, assuming you have the funds and financial security to do it, a recession could also be a good time to invest. This is particularly true if the recession is accompanied by a market correction or a bear market. If you see a significant drop in the value of stocks and you have cash on hand, you can invest at a much lower price (this is called “buying on the dip”).
Get One-on-One Help With Mentoro
You may not know that a recession is on the horizon until it is too late to do much about it. For this reason, you should start preparing for economic hard times now. In fact, it is never too soon to start building a cushion and making yourself less susceptible to risk.
Fortunately, if you are not sure exactly how to proceed, Mentoro can help. In addition to our online tools to help you track spending and savings, we offer one-on-one consultations with experienced financial educators. With our help, you can develop a strong financial plan to prepare yourself for the next recession.
If you want to learn more about how to prepare for a recession, be sure to contact the experts at Mentoro today!