7 lessons from the recession and how to prepare for another one

7 lessons from the recession and how to prepare for another one

7 lessons from the recession and how to prepare for another one

Don’t get caught in the crunch.

7 lessons from the recession and how to prepare for another one

    As has been documented in your news feed ad nauseam, Coronavirus has been a game-changer. The pandemic is impacting a lot of people, not just directly, but indirectly as well. In addition to the widespread sickness, lots of people have gotten laid off or seen their incomes drop.

    As a result, the pandemic has opened a lot of eyes and shown people just how quickly things can change.

    Consensus among economists and strategists is that the United States is already in a recession, although it won’t be made official until the fall. Many have realized that they aren’t nearly as prepared as they thought they were, and are wondering what to do now.

    Lessons learned from 2007-2008

    Many people have never been through a serious economic downturn like this before. The nearest thing that many people can think of is the Great Recession of 2007 and 2008. And, while this current downturn is going to be different from that one in many ways, it still holds many great lessons that people can and should learn from and apply to this crisis.

    Here are some of the most important lessons to draw from the last recession:

    1. Things can fall apart quickly

    Most Americans live paycheck to paycheck to cover debt payments each month including student loan payments, credit card spending, medical bills, etc. Under normal circumstances, the leverage that most Americans use actually helps the economy run. But, in some cases, the use of debt can also bring the economy screeching to a halt.

    Perhaps the worst thing about debt is that it becomes part of people’s daily lives. Once it is, it’s no longer seen as a luxury. It stops being an option for small families to afford a comfortable four-bedroom house instead of a two-bedroom apartment. Instead, it becomes something they need to run their daily lives.

    What people forget is that in a downturn, lending can stop almost instantaneously. One week, everything is fine and the next week it’s not. Banks can be sold or closed over a weekend. And, once credit isn’t available, all economic activity can dry up REAL quick.

    On a personal level, having debt or relying on it to meet their expenses can make people feel the pinch of a cash shortage after even a few small setbacks.

    2. You don’t have to lose your job to be impacted

    Over the past several weeks, people have been seeing the costs of self-isolating in order to slow the spread of coronavirus. People are stocking up on food, toilet paper, and other essentials. Price-gouging is rampant on sites like Amazon and eBay. But, even where prices remain normal, people are still having to buy things in larger-than-normal quantities, which isn’t cheap.

    In previous recessions, non-salaried workers like real estate agents or car salespeople have seen commission income evaporate almost overnight. Banks have closed. Housing prices have declined and slashed people’s net worth by 30%, 50%, even 70% overnight.

    The takeaway here is that people can suffer significant financial strain even without seeing their incomes go to zero. This makes it all the more important for people to structure their finances so they can pay their bills even after seeing their income or net worth drop. It can help to have identified expenses that they know they can cut (and cut them quickly) if necessary.

    3. Not all pain is in your wallet

    Whenever there is any recession or any kind of calamity, people are affected in ways they don’t expect. Today, people are trying to adjust to things like state-wide school closures, business shutdowns, food shortages, price gouging, and a lack of childcare. Some people are probably battling with low connectivity while trying to work remotely for the first time.

    Plus, there’s the extreme stress of not knowing if you or those you love could be impacted, even if you aren’t.

    In the last recession, in addition to wondering if they would lose their job, millions of people saw their net worths decline precipitously almost overnight. Many had to worry about losing property if their loans were called or they were unable to refinance before their mortgage rates adjusted.

    The bottom line is that people need to be prepared for pain that isn’t just related to cash flow. Be ready to steel yourself against the inherent stressors of a downturn and everything that comes with it—uncertainty about jobs, housing, even food.

    4. Cash never lasts as long as you think it will

    People who are directly impacted by lay-offs during a recession are always shocked at how their savings never seem to last them as long as they expect. Even when people just have their hours cut or are unable to work due to things like shutdowns, they can run out of cash very quickly.

    Sadly, the same thing happened in 2007-2008, but for different reasons. Then, as now, people often relied on credit even for simple things like paying household expenses. Suddenly, lenders stopped extending credit and people didn’t have the cash to cover even small bills.

    If you’re lucky and still have your job, hoard cash. Build your emergency fund and try to accumulate several months of financial cushion as quickly as you can—even if it means putting a hold on paying down debt. If you end up being laid off later, there’s no telling when you’ll be able to find another job and you’ll need to support yourself in the meantime.

    5. Even side hustles can get cut

    The growth of the gig economy is one thing that makes the world vastly different from the last recession. And yet, even though millions of people now have side hustles who didn’t the last time there was a recession, many people think they can rely on this outside income to help provide a financial cushion. And they can’t.

    During a recession, disposable income largely dries up—except for small segments of the population with abundant savings. People simply don’t have money to spend. Or, they aren’t certain about their own financial future, so they also hoard cash. What ends up happening is that the income from your side hustle—what you thought was your financial cushion—can disappear just as fast as a full-time job. Sometimes even faster.

    6. The biggest risks are the ones you don’t see coming

    Up until 2006, nobody ever thought housing prices would go down. Few living Americans had ever seen it happen—except for local cases, where prices could be impacted by things like business closures.

    Something similar happened this time around: the risks of a pandemic weren’t widely recognized, so nobody prepared for it (not even the federal government).

    To prepare for a recession, you really have to think beyond the risks that quickly come to mind. Even now, the thing that impacts you personally probably won’t be the thing you see coming.

    For example, you and your family may stay perfectly healthy through this entire mess. You may not even get laid off. But what if your employer goes bankrupt? Or your boss fails to get the SBA loan they need to meet payroll? Or what if your company’s biggest customer goes broke?

    It’s important to assess your risks, no matter how unlikely they may seem. Even those risks that don’t come to mind immediately can end up being the ones that impact you the most, and knowing how to respond is critical.

    7. Some investments will remain stable

    In any recession, there are some investments that will continue to make money as though there’s nothing remotely wrong. For example, in spite of all the uncertainty of the past months, rental income has remained relatively stable (for long-term rentals; AirBnBs, not so much). And, even though stock prices are way down, bond prices have avoided collapse.

    Still other investments, people will soon find, will recover much faster than others. It might be stock prices, real estate values, or something else, but some things will outpace the rest once things stabilize.

    How things have changed since 2008

    Without a doubt, a lot’s changed since the last recession in 2007-2008. The world looks a lot different, whether it’s the growth of the gig economy or the normalization of things like mortgage rates and lending standards. It’s important to understand how things are different in order to see how this recession will unfold compared to the last.

    Leverage isn’t the problem

    In 2006 and 2007, banks and financial institutions were drastically over-leveraged, and that excess debt had largely trickled into the broader economy through lax lending standards and complicit ratings agencies. When things started down, there was a lot of uncertainty because people didn’t even know which banks were going to survive—or if the entire financial system was going to come down on our heads.

    However, that’s not the case this time around. A lot of people are going to be hurt financially in this recession, but it won’t be because there was too much debt in the system. Instead, it will be because millions of businesses had to shutter in order to slow the spread of coronavirus. Or, it will be because people had to pay exorbitant rates for things like toilet paper for weeks while sitting at home in quarantine. Or they got hit with medical bills that they didn’t expect and weren’t capable of paying.

    The pain points are different

    In the last recession, the pain that most people felt was purely economic. And, more often than not, it had more to do with the value of assets rather than a sudden drop in income. A lot of people got hurt because of decisions they probably shouldn’t have made in the first place, such as buying 4th and 5th houses or buying homes with no money down.

    This time around, people are feeling a very real short-term cash crunch as millions of jobs suddenly disappear and the government works to distribute stimulus checks and sufficient unemployment benefits for people to cover their basic costs of living.

    These two things aren’t the same. Nor will the next recession look anything like this one or the last one in 2007-2008. That’s why it’s important to keep your eyes open to all potential risks and try to insulate yourself as much as possible.

    The Fed moves quickly now

    One of the big things that magnified the last recession was that the financial system almost collapsed from excess debt and neither the government nor the Federal Reserves had adequate tools to stop it. The government had to push through new legislation to give the Federal Reserve authority to do things like buy bad debt (the Troubled Asset Relief Program, or TARP). Up until then, there was simply no mechanism for the Treasury Department or the Fed to stave off disaster.

    Because the government was caught asleep at the wheel, it took far too long to institute programs that provided a backstop in 2007 and 2008. Fed intervention in the markets took too long, resumption of credit took too long, and stimulus checks took too long (and were too small).

    That’s not so this time. The coronavirus pandemic didn’t really start impacting the United States until mid-March, and just four weeks later we’ve passed sweeping stimulus legislation to provide individual Americans with checks and forgivable loans for small businesses, to say nothing of large-scale Fed action to prop up markets over the past weeks.

    Things fall apart faster now

    Leading up to the collapse in 2007, there were a lot of people who saw trouble brewing. They recognized that there was too much debt in the financial system. Many weren’t sure what would touch off a crisis, but they knew that one was coming.

    When the crisis finally did start, it took a few months to unfold. At first, it seemed isolated among just one or two banks. It wasn’t until later that regulators and legislators recognized how big the problems really were.

    What’s astounding is that now, just 12 years later, the world is vastly more connected than it was back then. When things go bad, it doesn’t happen slowly. So, where before people had weeks to see what would unfold and decide how to react, people now have to be prepared for things to happen much faster.

    The gig economy is here to help

    Many people are finding that potential income from side hustles is declining amid this pandemic, but they forget that many of these opportunities didn’t even exist in 2008. Back then, Uber and Lyft were still in their infancy, Etsy wasn’t really a thing, and there were far fewer opportunities for remote work than there are today.

    This time around a lot of gig workers are seeing a dip as a result of social distancing and self-isolation and stay-at-home orders, but that won’t last for long. Once the pandemic blows over, side hustles will be there to help people’s incomes while the broader economy recovers.

    Here are some tips to help you prepare

    In light of these lessons from previous recessions, you may be wondering what you can do to prepare—if not for the recession we’re already in, then for the next one.

    What follows is in no way a comprehensive list, but a few ideas for how to weather recessions in general:

    1. Keep some cash at home

    Anytime there’s economic uncertainty, there are myriad risks that can prevent quick access to cash or credit. There can be bank holidays or closures, bailouts, credit freezes, and other things. But, in the meantime, we all still have bills to pay. The best thing to do is to try to keep a little cash at home—just enough to meet critical expenses if you do encounter a liquidity problem.

    You don’t need enough to support yourself for a year or anything, but having enough to get by for a few days or weeks can relieve a lot of stress.

    2. Know how to cook and keep your kitchen stocked

    Yes, cooking can be a pain. And no, doing dishes isn’t fun. But this pandemic has shown that gone are the days of thinking it’s ok to just be one of those people who “doesn’t cook.” A few months ago, people would’ve thought it silly to think they needed to have a ready supply of food at home, but many are now realizing that failing to have enough on hand to last even a week or two can make it much more expensive if you have to go stock up.

    So, instead of putting yourself in a position of having to find food in the middle of a crisis, try to keep some necessities on hand.

    Granted, people don’t need much just to survive. And you want to be able to pay your bills, so spending everything you make on canned goods shouldn’t really be the goal. But, when things suddenly go very wrong, the most important things are being able to feed yourself and keep your power on. Food, water, shelter—everything else is secondary when things get crazy.

    3. A little self-reliance goes a long way

    Americans are used to thinking there will always be someone who can help with their problem. A restaurant that delivers. An Uber for a ride. And a hospital or a doctor for medical care. A handyman to fix a leaky faucet.

    But, these things aren’t always available in times of serious turmoil. So it’s important to know how to do basic things yourself and have what you need in case things shutdown. This may mean keeping a store of medicines that you need, keeping a small garden, or keeping an extra pack of toilet paper squirreled away.

    4. Be smart about how you pursue your financial goals

    If you’re reading this, you probably aren’t someone who lives paycheck to paycheck. If you are, you’re probably realizing already that’s not a good idea.

    The thing to remember is that recessions can and should cause us to reassess financial goals.

    Sometimes, we have to put a pause on the ideal in favor of the expedient. So while, in normal times, you may have made the wise decision to pay down debt, right now you may need to reassess and focus on building more of a cash cushion to meet your immediate needs.

    Note, too, that changing your focus short term doesn’t necessarily mean that you’re abandoning your goals. In fact, it may be just another way of pursuing the same objective.

    For example, paying down debt is one way to increase your net worth. Hoarding cash (so long as you aren’t doing it by borrowing more) is just another way of doing the same thing.

    Plus, when things go back to normal, you may find yourself with a nice chunk of cash to pay down a bunch of debt all at once.

    5. Always keep a side hustle on deck

    A job can be lost at a moment’s notice, and unemployment benefits take time before they kick in. Even if you work for yourself, clients can cancel work or go broke. If something happens, it’s important to have something ready to get some cash coming in—even if it’s not a lot.

    For more information on which side hustles are best to last you through recessions or crises like the pandemic, be sure to check out our list of the Most Insulated Side Hustles.

    6. Be ready to invest

    We’ll leave you with this, and it’s important for those looking to stay on track through economic downturns.

    Things will get bad for the economy from time to time, and no one will ever know how long it’ll last. But, we do know that things will get better. And, while it may sound cold, times like these are usually some of the best times for investing. Prices get distorted, and you can find good investments for cheap because someone else needed to sell.

    So, it’s important to be ready to recognize opportunities and take advantage. Keep an eye on the types of investments you want to own and, when they’re at prices that you would’ve found attractive BEFORE the downturn, start to buy. Keep in mind, this should be done with a long investment horizon in mind. It could be years before prices recover, but you want to take advantage and buy while prices are lower than where you think they’ll be in 5, 10, or 20 years time. For more information on investing, check out our Expert's Guide to Index Investing here.

    What has the 2007-2008 recession taught you? Anything we missed? Let us know in the comments.

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    Dock David Treece

    27 posts

    Dock is a former financial advisor and an experienced real estate investor who loves helping people find ways to build and conserve wealth. He has been featured by CNBC, Fox Business, and Bloomberg.