How to Prepare for a Recession
A recession doesn't necessarily have to be doom and gloom if you're properly prepared.
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You've heard the term, and you know it's not good, but maybe you're not exactly sure how to position yourself to minimize any potential damage—or even better—how you can come out ahead on the other side.
The word “recession” by itself is...scary. So let's take a closer look at what a recession is, what causes it, and the best practices for navigating it.
What is a recession?
A recession is an overall economic downturn. Production generally slows, unemployment rises, and the Gross Domestic Product (GDP) starts to shrink.
It should be noted that economic recessions are different from economic depressions. They are shorter and easier to recover from since they cause less harm. Recessions are generally measured in months, though the Great Recession in 2008 lasted about a year and a half.
Recessions are a normal part of how an economy functions and help the market to correct itself. For example, if a stock or asset is overvalued, the bubble will burst, causing a recession while the market corrects itself to measure the value more accurately.
In contrast, economic depressions last years have much more devastating effects, making them much harder to recover from. The United States has only experienced one depression: The Great Depression, which lasted 10 years.
What causes a recession?
The Congressional Research Service identifies three main causes of a recession:
- asset bubbles
- economic shocks
Overheating happens when inflation rises, often as a result of high consumer demand and low supply levels. Low unemployment rates can also be a symptom of overheating as businesses hire more workers to meet the increased demand.
Sometimes a stock or category of stocks increases its value rapidly and becomes overvalued, creating a bubble. Eventually, the bubble bursts as the market corrects itself to value the stock or asset more accurately. A common example is the 2008 housing crisis when subprime mortgages were overvalued.
Unexpected events can also affect the economy. The outset of the COVID-19 pandemic caused a two-month recession. Although that recession was brief, the United States is still dealing with the on-going effects of the pandemic on the economy and the stress it put on global supply chains. These challenges have been compounded by recent global political events.
How can I protect myself from a recession?
A recession doesn't necessarily have to be a terrifying hellscape. In fact, if you play your cards right, it could actually be an opportunity.
The following are a few strategies that I use during an active recession.
During a recession, my number one priority is making sure that my emergency fund is fully loaded. I sleep better with the peace of mind that if I were to lose my job tomorrow, I would still be able to pay my bills for 6+ months.
The job market tends to get volatile during a recession, so I like to know that I’m financially secure in all scenarios.
Review your budget & tighten your belt
First things first, make sure your basic needs are met and review your recurring expenses.
This is fairly obvious advice that doesn’t just apply to periods of recession, but it’s worth mentioning. It’s a good idea to look at your monthly spending to see where your money is going and if there’s any room for improvement.
I reviewed my spending recently and realized that I was spending way too much on takeout and streaming services that I wasn’t really even using.
I cut the spending on takeout by signing up for a meat delivery service. Now the meat shows up at my door, and I have so much of it that I don’t feel right about ordering takeout.
I also canceled 2 out of the three streaming services I was subscribed to—and I don’t even miss them.
After you’re done budgeting and belt-tightening, hopefully, you can use some of your new-found funds to pay down any debt that you may have accrued.
The less debt liability you have, the more nimble you can be to fund your emergency account and invest for retirement.
Many people’s first instinct when they hear about an economic downturn is to panic, stop investing, and maybe even sell off what they already have in the market.
I understand why people feel that way, but during times of recession and bear markets, I tend to view this as an opportunity. Since so many people are panic-selling, stock prices plummet, and I consider that as an opportunity to pick things up “on sale”.
I learned in Jeremy Schneider’s investing course that historically, S&P 500 index funds have rebounded every time there has been a dip. While there are certainly ups and downs and no one can tell the future, I consider S&P 500 index funds to be a relatively safe investment at any time.
If you’re looking for alternative options that may carry lower risk, you may want to check out our breakdown on I-bonds.
If you haven’t already, consider starting a side hustle. Having a side hustle will help you add to your current income, as well as maintain a stream of inbound cash in the event that you are laid off.
Invest in yourself
Recessions can also be a good time to return to school for more training that can help you gain marketable skills to increase your employment prospects. Consider your financial and career goals as you evaluate educational opportunities.
There are also a number of online professional training programs through platforms like Coursera, Udemy, SkillShare, or LinkedIn Learning that are low-cost or in some cases completely free.
A final word on recession preparedness
While a recession is never going to be a fun time, it doesn’t necessarily mean that the sky is falling like the news might have you believe.
There are steps that you can take to minimize negative impact, and maximize your opportunities to come out ahead on the other side.
The opinions expressed in this article are for general information purposes only and are not intended to provide specific advice or recommendations about any investment product or security. This information is provided strictly as a means of education regarding the financial industry.