Content of the material
- So, what is a recession?
- Start Budgeting for Free
- Diversify your portfolio
- Plan for the Long Term
- What You Shouldn’t Do During a Recession
- Abandon Disciplined Investing
- Take on Big Expenses
- 2. Start building your rainy-day reserves, if you haven’t already
- Is it good to have cash in a recession?
- Mistakes to Avoid During a Recession
- 4. Think about your career
- What Is A Recession?
- Are We Going Into a Recession?
- Are we in a recession today?
- 3. Build a substantial emergency fund
- 5. Dont make knee-jerk reactions with your investments
- Invest in Technology
So, what is a recession?
Well, economies are cyclical. That means they go through periods of expansion and growth, as well as periods of decline known as recessions. Or more severely, depressions.
For example, You know about the great recession of 2008 triggered mainly as a result of the housing bubble in the United States. There’s also the COVID-19 Pandemic that emerged globally, severely impacting 2020.
During a recession, there is typically a decline in industrial and trade activity. Some major implications that come with recessions include job losses and unemployment, a drop in real estate values, and the decline of investment values. And as a result, this decline can severely impact your personal finances.
This is why it’s essential for you to know how to prepare for a recession.
That being said, regardless of whether there’s a recession going on or not, life goes on, and bills need to be paid. The last thing you need is for a recession to become a personal financial crisis for you.
Start Budgeting for FreeGoodbye, money stress. Hello, EveryDollar. Set up your account and build your first budget today. (And it’s free, who doesn’t love that?) Budget With EveryDollar
Diversify your portfolio
Diversification is critical when preparing for a possible economic recession, said Anthony Watson, a CFP and founder and president of Thrive Retirement Specialists in Dearborn, Michigan.
You can eliminate company-specific risk by opting for funds rather than individual stocks because you're less likely to feel a company going bankrupt within an exchange-traded fund of 4,000 others, he said.
Value stocks tend to outperform growth stocks going into a recession.Anthony WatsonFounder and president of Thrive Retirement Specialists
He suggests checking your mix of growth stocks, which are generally expected to provide above-average returns, and value stocks, typically trading for less than the asset is worth.
"Value stocks tend to outperform growth stocks going into a recession," Watson explained.
International exposure is also important, and many investors default to 100% domestic assets for stock allocations, he added. While the U.S. Federal Reserve is aggressively fighting inflation, strategies from other central banks may trigger other growth trajectories.
Plan for the Long Term
Generally, your investments are most profitable left untouched. This is especially true during recessions, when panic selling your stocks can result in loss while staying invested gives the market time to rebound.
As you enter a recession, Turner reminds you to stay calm and consult an expert.
“Before you start moving your investments around, talk to your financial advisor,” he says. “Different investments — stocks, bonds, mutual funds — can behave differently in a recession. A professional advisor can guide you through the best steps to take for your particular situation.”History Repeats Itself
The greatest days for stock investors often follow the worst, and pulling your investments during downturns could have huge implications for your return potential. Investors who missed the 10 best days of the decade saw a 91 percent return on average, compared to those who maintained their long-term investments and saw a 14,962 percent increase.
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.
2. Start building your rainy-day reserves, if you haven’t already
Recession or not, you should have an emergency fund. These savings help you avoid borrowing money to cover unforeseen costs like repairs, medical treatments, or job loss.
Emergencies are just that — unexpected. And many people are unprepared for them: 25% of Americans say they have no emergency savings at all, according to a study from Bankrate.
If you’re just starting out, I recommend having around six months’ worth of expenses, including the amounts you spend on necessary items like rent, utilities, and groceries. That number may sound high at first, but small contributions over time can build those savings.
You’ll want to store your emergency money in a liquid account (like a high-yield savings account) to easily access it when you need it.
Is it good to have cash in a recession?
It is always great to have cash on hand, at least a three-month emergency fund. Low interest rates on savings and money-market accounts during recessions mean that big stores of cash may be unattractive compared with other tools.
Mistakes to Avoid During a Recession
During an economic downturn, avoid putting your finances at risk and prepare for any emergencies. Here are some common mistakes you’ll want to avoid:
- Panicking: Steer clear of fear. If sudden changes spark anxiety, take a deep breath and see if there’s an upswing shortly after. If you’re unsure of any economic changes, reach out to a financial advisor.
- Increasing your debt: Even though recessions may lower interest rates on loans, avoid taking on more debt. Instead, focus on paying off any debt you already have.
- Becoming a cosigner: In the event the primary debt holder isn’t able to make a payment, the cosigner is held responsible. To avoid taking on more potential debt, stay away from cosigning.
- Taking your job for granted: Whether you want to stay at your job for a while or not, always showcase your skills. During an economic downturn, highlight these skills and put off quitting until you have another opportunity lined up.
- Not building an emergency fund: You may need supplemental income for your daily necessities and unexpected events. Build up your emergency fund so you can cover at least three to six months of your expenses.
- Taking on more fixed expenses: Focus on decreasing your overall expenses. Evaluate what you can eliminate from your budget and avoid increasing your fixed expenses, like a new car payment or an expensive apartment.
- Not having a backup plan: First, create a budget that works for you and adjust as you go. Update your resume, save extra cash, or start a side hustle for extra backup opportunities in case things take an unexpected turn.
No matter the state of the economy, practicing these healthy financial strategies can help improve your budget and opportunities. The best way to increase your savings and prepare for unexpected events is to track your budget, frequently adjust it, build up your emergency fund, and seek opportunities to improve your experience. Level up your savings accounts and career while practicing good financial habits.
4. Think about your career
Recessions historically go hand-in-hand with higher unemployment — which means preparing your career for the next downturn is essential.
Now’s a great time to reach out to your network and continue to maintain connections with others in your field. Typically, higher education comes with lower rates of unemployment – so if you’ve been thinking about going back to school, now may be the time. Adding new skills or bolstering your current ones could give you an edge in a future, tighter job market.
Be sure to weigh the pros and cons of potentially forgoing a salary or taking on student loan debt to earn your degree. I would also recommend being practical about what industry you’re considering. No job is completely protected from recessions, but certain industries are safer from cuts.
What Is A Recession?
A recession is a sustained period of weak or negative GDP growth that marks a sharp decline in economic activity across sectors. Recession identification considers several economic factors, including:
GDP Personal income Employment levels Industrial production
Economic declines including any of these factors for several months in a row may be considered a recession. Typically, recessions are accompanied by high unemployment rates.
Recessions can be difficult to weather, but they’re not uncommon and should be considered in your regular financial planning. In fact, the U.S. has experienced 13 recessions in the last 100 years since the Great Depression.
Are We Going Into a Recession?
Recessions are kind of like tornadoes. It’s hard to predict when they’ll hit and how much damage they’ll cause. But instead of downed trees and smashed houses, the damage from a recession usually looks like this: lost jobs, a tanking stock market and bankrupt businesses.
Now, you might not personally feel the effects of a mild recession (though you’ll definitely hear about them in the news 24/7). But a moderate or severe recession will definitely get your attention.
America’s last recession came and went super quick in 2020 when the whole world shut down in response to the coronavirus pandemic. The National Bureau of Economic Research didn’t even wait for two quarters of negative GDP growth to declare a recession. (Yep, that bureau is responsible for telling us when we’re in a recession.)
So, are we going to have a recession?
Wondering why we’re being so matter-of-fact about the whole thing? Well, recessions are a natural part of the economy, so it’s a given that we’ll have them from time to time. We’ve actually had 12 recessions since World War II, and the average length of each was about 10 months.2
So, the real question isn’t if we’re going to have a recession but when we’re going to have one, and that’s more difficult to answer. But we have seen some signs that a recession could be coming.
Sometimes the signs of recession are super obvious (cough, COVID shutdowns, cough). But others are more subtle. People who study the economy for a living even disagree over when the U.S. will have its next recession.
We said earlier that a recession is usually defined as six months of falling GDP. So, here’s the bad news: GDP declined by 1.4% in the first quarter (aka first three months) of 2022.3
Now, that might make you think, We’re halfway to a recession! Well, maybe . . . or maybe not. Other economic indicators like consumer spending and unemployment are still doing okay.
But then there’s the big thing on everyone’s mind: inflation. We’ve all felt the effects of higher prices, and that’s why the Federal Reserve (the U.S. central bank) has started raising interest rates to try to slow inflation. The Fed is stuck between a rock and a hard place because rising rates slow GDP growth and could push the economy into a recession.
Oh, yeah, and in case you haven’t noticed, the stock market has been in a nose dive lately. Wow, that’s a lot to worry about. But there’s always hope!
The important thing to remember is that no matter what the economy does, this economic trouble is temporary. If you’re reading this, you’ve lived through at least two recessions. And you made it!
With that being said, it’s always good to be prepared as if a recession was coming.
Are we in a recession today?
We are not currently in a recession, however the risk of recession has grown in the wake of Russia’s war on Ukraine, with rising gas prices and the Federal Reserve’s attempts to combat inflation by increasing interest rates.
The National Bureau of Economic Research Business Cycle Dating Committee announced that the 128-month expansion (the longest in U.S. economic history) ended in February 2020.
3. Build a substantial emergency fund
Jobless Americans can often turn to unemployment insurance (UI) for help with income. How much each individual receives depends on the state, but generally about 30 to 50 percent of workers’ wages are replaced with the assistance program, according to the National Bureau of Economic Research. That’s unless Congress enhances the program, as lawmakers did during the coronavirus pandemic.
Assembling six months’ worth of expenses can seem like a daunting task, but don’t underestimate the power of small contributions. Regularly adding to your savings account over time can build the crucial savings habit. Better yet, automate your contributions to put the process on autopilot. For more tips, take Bankrate’s free financial education course on building your emergency fund.
Next comes the important step of deciding where to park your cash. Savings accounts from online banks often offer yields that are 10 times the national average. Shop around for the best account that suits your needs and lifestyle.
5. Dont make knee-jerk reactions with your investments
A downturn might seem synonymous with a plunging stock market since companies often find it hard to hire, expand and invest when times are tough. Even worse, they might decide to start laying workers off.
But changing your strategy during a recession would be the worst thing you could do, McBride says. That goes for all individuals: whether they’re 20 or just two years away from retiring.
“It will take a tough stomach because in a recession a stock market will easily fall 30 to 40 percent, peak to trough, but making regular contributions and reinvesting all of the distributions will make those market gyrations work to your benefit,” McBride says. “A recession is a tremendous buying opportunity.”
If you’re planning to retire in the next few years, consider having your first few years of withdrawals already on hand, in cash. But even then, don’t shy away from keeping equities in your portfolio. Those are often where you’ll get the best returns adjusted for inflation — a concern that many Americans are having to grapple with, after prices in February soared by the fastest rate in 40 years.
“Do not make changes that jeopardize your long-term financial security based on short-term economic events,” McBride says. “Even for someone who is on the cusp of retirement, retirement is going to last 25 to 30 years. A recession is going to last a year.”
Even so, the market doesn’t always behave the way you’d expect it. After plunging nearly 31 percent in March 20, 2020, the S&P 500 took off like a rocket during the coronavirus pandemic, hitting 70 fresh all-time highs in 2021 alone, despite the economy being in the worst recession since the Great Depression. A large part of that was the Fed’s go-big-or-go-home efforts to revive the ailing economy, which instilled confidence in investors.
Invest in Technology
It’s tempting to think of a recession as a time to batten down the hatches and play it safe. However, downturns actually appear to encourage the adoption of new technologies. In a 2018 paper, Brad Hershbein (of the Upjohn Institute for Employment Research) and Lisa B. Kahn (of the University of Rochester) compared more than 100 million online job listings posted from 2007 to 2015 with economic data to see how the Great Recession affected the types of skills employers were looking for. They found that the U.S. cities hardest hit by the recession saw a greater demand for higher-order skills—including computer-related skills. The boost in demand was partly due to employers’ taking advantage of high unemployment to be choosier, as suggested by Alicia Sasser Modestino (of Northeastern), Daniel Shoag (of Harvard Kennedy School and Case Western Reserve), and Joshua Ballance (of the New England Public Policy Center). Their study found that the demand for tech skills returns to more normal levels once the labor market improves.
But companies weren’t only being choosier, Hershbein and Kahn found; they were becoming more digital, too. In those hard-hit areas of the United States, companies also increased their investment in information technology, driving the surge in IT skill requirements in their job postings.
Why do companies invest in technology during a recession when money is tight? Economists theorize that it’s because their opportunity cost is lower than it would be in good times. When the economy is in great shape, a company has every incentive to produce as much as it can; if it diverts resources to invest in new technologies, it may be leaving money on the table. But when fewer people are willing to buy what you’re selling, operations need not be kept humming at maximum capacity, which frees up operating budget to fund IT initiatives without dampening sales. For that reason, adopting technology costs less, in a sense, during a recession.
That’s fine in theory, but other reasons may make more practical sense to managers. Technology can make your business more transparent, more flexible, and more efficient. According to Katy George, a senior partner at McKinsey, the first reason to prioritize digital transformation ahead of or during a downturn is that improved analytics can help management better understand the business, how the recession is affecting it, and where there’s potential for operational improvements.
The second reason is that digital technology can help cut costs. Companies should prioritize “self-funding” transformation projects that pay off quickly, George says, such as automating tasks or adopting data-driven decision making. The third reason is that IT investments make companies more agile and therefore better able to handle the uncertainty and rapid change that come with a recession. In manufacturing, “we are finally seeing uptake now in the adoption of digital and advanced analytics,” she says. It used to be that a manufacturer could be the cheapest in the market or could stay nimble—but not both. Flexibility came with serious costs. However, digital technologies “create much more flexibility around product changes, volume changes, etc., as well as around movement of your supply chain around the world.”
That, in George’s view, is one way the next recession might be different from past ones. Companies that have already made an investment in digital technology, analytics, and agile business practices may be better able to understand the threat they face and respond more quickly. As we’ve seen, recessions can create wide and long-standing performance gaps between companies. Research has found that digital technology can do the same. Companies that have neglected digital transformation may find that the next recession makes those gaps insurmountable.A version of this article appeared in the May–June 2019 issue (pp.98–105) of Harvard Business Review.