Now Is The Time To Get Financially Healthy. Five Things To Do In Case Of A Recession.
There is a lot of talk around recession right now. Is the US in a recession? Are we headed into one? This should be a yes or no question, but experts are mixed. According to the general definition—two consecutive quarters of negative gross domestic product (GDP), the U.S. entered a recession in the summer of 2022. However, many experts believe the strong corporate earnings and labor market show the US hasn’t reached recession levels. Regardless of the exact definition, with interest rates continuing to rise to fight inflation, the US may be heading into a recession territory soon.
Luckily the way to prepare for a recession is fairly consistent with how to manage your finances during strong economic growth. There are five simple things you should do now to prepare for a recession – whether it comes or not.
- Create a budget. As much as we may hate the idea of a budget, try to look at your budget as a way to track where you spend, establish healthy habits for the long run and meet your goals. Never is a budget more important than in a recessionary period, because there is a chance your income could be reduced. The goal of a budget is to be able to cover your expenses and save towards goals like retirement, home downpayment, etc. If you struggle with expenses, now is the time to take a hard look at your budget and split your expenses into fixed and discretionary. Of the discretionary, what can you cut out? Create two levels of cuts as needed. The first budget cut is to reduce any wasteful, irresponsible or unintentional spending. The second cut is what you can cut out in an emergency situation, to spend as little as possible. For example, you may have noticed that your entertainment spending is way more than you can afford, and there is room for improvement. In the first cut you want to be sure you’re spending responsibly and may want to reduce your eating out to just once a week instead of 3x/week. The 2nd cut happens when you are worried about covering your bills and need to make some major changes. This is the time to cut all dining, happy hours and movie nights until the situation improves.
- Have an emergency fund: An emergency fund is savings you can use if something unexpected occurs, like car trouble, medical bills, busted water heater or job loss. This fund should be in cash so you can access it easily and should be enough to cover 3-6 months of expenses. Three months may be sufficient if you are easily employed, live in a strong job market and/or have a partner that works. You may need closer to six months if you are in a highly specialized role or niche industry where employment is harder to find. The reason an emergency fund is so important during financial downturns is it provides protection if you lose your job. Emergency funds should always be a top priority, but recessions often come with declines in employment, and make us all more vulnerable to losing income. Without an emergency stash, something as simple as a car breaking down may force the use of a high interest credit card, which can create all types of long-term financial problems.
- Evaluate your earning potential and career. This is not to say this is the time to make a major career change – it’s not. However, it’s time to look at your earning potential and how you could increase it. If your current career is solid, what can you do to enhance your potential in the company? Maybe look at professional development programs or additional training. If you are worried you could lose your job, explore side gigs and ways to bring in extra income. Something you should always do regardless of current career success is to network in and out of your industry. Connect with anyone and everyone who could potentially be a resource down the road if needed. And pay it forward – offer to provide career help to those who need it.
- Manage investments for the long term. This basically means don’t panic and sell all of your investments. If the market tanks and you sell when it’s low, you are guaranteed a loss. Keep in mind that a market cycle is between 3-5 years, so that’s at least how long you should keep investments so they have a chance to recover their losses. When you invest, invest for the long-term in high quality companies and funds you believe in and have done your research on. On the flip side, don’t try to ‘catch a falling knife’ either. This is an expression for when a trader buys a stock after a big drop in its share price, hoping the price will rebound, but the stock price continues to fall. Timing the market like this is difficult, even for the experts.
- Pay off high interest debt. Again, this is a good rule of thumb regardless of the economic situation. That’s because the higher the interest rate, the more money you’re charged in borrowing fees. By paying off this debt, you’ll reduce the total amount you owe faster and the interest won’t have time to compound. Paying high interest credit cards and loans first is called the avalanche method, and almost always a good strategy to manage debt.
These steps are just good financial habits that lead to being financially healthy, independent and secure. Whether the economy is strong or weak, continue to monitor your spending, save for an emergency, evolve in your career, invest intentionally and keep your debt low.