A recession can challenge your finances, so it’s important to be prepared for periods of economic weakness. In fact, it’s ideal to keep your financial life in good shape whether or not you anticipate a recession. That way, you might not need to react if the economy goes into a recession.
The National Bureau of Economic Research (NBER) defines when recessions begin and end based on changes in measures including unemployment, income, and industrial output. But most people simply notice difficult economic conditions. You might see slower earnings growth, more frequent job losses among those around you, and other headwinds that affect your financial goals. But with the tips below, you can improve your chances of emerging from the next recession in decent financial shape.
Pay Down Debt
One way to get prepared is to pay down—or eliminate—debt. Doing so can reduce your monthly obligations, making it easier to absorb any speed bumps you hit during a recession. For example, if you lose your job or work fewer hours in a slow economy, life will be easier with fewer or lower monthly payments.
But be strategic when paying down debts. Building up emergency savings might make more sense than aggressively paying down debt, according to Jovan Johnson, a certified financial planner (CFP) at Piece of Wealth Planning, LLC. “If there is an adequate emergency fund set in place, it may make sense to pay down credit card debt,” Johnson told The Balance by email. But if you put all of your free cash flow toward debts, you may be unprepared for surprises—and having a cushion of cash could be valuable in a recession. That said, once your cash-flow situation is secure, Johnson favors prioritizing high-interest-rate debt payoff.
Reassess Your Budget
It’s always wise to monitor your spending, and that’s especially important during hard times. “Make sure each dollar is accounted for and has a purpose,” Johnson said. That’s something you can accomplish with a zero-based budget, which promotes intentional spending.
When you plan your spending carefully, every dollar of income goes toward a specific expense. For example, you anticipate spending for categories such as housing, food, loan payments, and utilities. But what happens if you earn more than you spend on bills? You add additional categories for saving (emergency fund, retirement savings, vacation fund, and so on). As a result, you’re less likely to spend money on luxuries that might prevent you from meeting financial goals.
Eric Roberge, CFP at Beyond Your Hammock, told The Balance by email that now is the time to take action on your spending plan; don’t wait until a recession is in progress. By getting proactive, you can free up cash flow to build a rainy-day fund. To accomplish that, you may want to hold off on major purchases, cut unnecessary spending, and focus on needs over wants, said Roberge.
Cutting your spending and building up an emergency fund can help you avoid going into debt or falling behind on bills if you lose your job because of the economy.
A rule of thumb for emergency savings is to keep three to six months’ worth of expenses in cash. But if you want to be even more conservative—or if you expect an extended economic downturn—it could make sense to build a bigger emergency fund. However, if that seems impossible, just start with what you can afford and add to it from there.
Focus Your Investments for the Long Term
Should you change your investment strategy to sidestep potential losses related to a recession? Roberge said, “The short answer to this is no—assuming you have a sound investment strategy that is designed for the long term.”
Trying to time the market by selecting recession-friendly investments may be frustrating and risky. You might be better off with a long-term strategy designed for all types of conditions—including recessions. When you use that approach, you don’t need to take action in anticipation of recessions because your plan already accounts for the fact that recessions (and other events) inevitably happen periodically.
As Johnson said, recessions actually may be beneficial if you’re in your accumulation years. If stock prices fall, systematic contributions to a 401(k) and other retirement accounts can buy more shares each month via dollar-cost averaging. Still, recessions can cause suffering for many, so this isn’t something to root for.
The situation could be different if you’re getting ready to retire. In that case, it may make sense to revisit your risk level because significant losses near the beginning of your retirement years can be problematic. If you’ve been dragging your feet on reducing risk, it could make sense to shift some money from stocks to lower-risk investments like bonds if you expect a bumpy economic road ahead.
Some people believe bitcoins could serve as a modern alternative to gold, which held up relatively well compared with the stock market during 2008. But Bitcoin and other cryptocurrencies are extremely volatile, and there’s limited history to support such predictions. While anything is possible, there are “no guarantees that crypto will serve as a hedge against recessionary times,” Johnson said.
What You Shouldn’t Do During a Recession
With a solid emergency fund and an all-weather investment portfolio in place, you might not need to make changes if a recession materializes. That’s the beauty of having your finances in order before you experience hard times: You can focus on more important things in life and support loved ones. Still, that’s easier said than done if you’re barely getting by during normal times, so don’t be too hard on yourself if you’re still working on your emergency fund.
Abandon Disciplined Investing
When it comes to your investments, be wary of making emotional decisions if the markets get ugly.
“If you change your investment strategy and sell out of investments each time the world seems unstable, then you'll end up buying high and selling low,” Lindsey Swanson, CFP at Great Lakes Investment Management, told The Balance by email.
Roberge takes a similar view. “Know that market volatility, corrections, and downturns are all normal market behaviors, and they're nothing to react to. In fact, reacting and trying to fiddle with your investments is exactly where average investors get into trouble,” he said.
Although it may be tempting to stop investing, continuing to invest during a recession could be a smart move. If markets eventually move higher, buying during hard times can add to your long-term returns.
Take on Big Expenses
When you risk losing a job or face other economic challenges, it may make sense to keep your expenses as low as possible. Adding significant monthly obligations like a hefty car payment may make things difficult if a recession affects your finances.
Frequently Asked Questions (FAQs)
How do you prepare for a recession if you’re retired?
Verify that you’re taking an appropriate amount of risk in your portfolio. If you own more stock than you’re comfortable with, it may make sense to reduce your exposure to stocks by shifting some of your money to bonds and cash. Speak with a financial planner to get specific recommendations and run “what if” scenarios.
When was the last recession?
The U.S. economy officially entered a recession in February 2020 after more than 10 years of economic expansion.
What causes a recession?
Economic slowdowns can happen for various reasons. Some of the most common causes include bubbles that eventually burst, unsustainable inflation, and shocks that disrupt normal economic conditions. As just one example of such a shock, the most recent recession was associated with widespread temporary shutdowns aimed at slowing the spread of COVID-19.