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How to Financially Prepare for a Recession

How to Financially Prepare for a Recession

| February 11, 2023

The state of the economy is outside our control, yet it impacts our financial life – sometimes significantly. When a recession looms and we know that rising inflation, high unemployment, and a falling stock market are likely coming our way, is there anything we can do to protect ourselves financially? The answer is yes. Continue reading to find out more.

What is a Recession?

Before we dive into this topic, let’s start by defining a recession. In general terms, a recession is simply a widespread and ongoing economic downturn. Technically, it’s marked by two consecutive quarters of negative GDP growth. GDP, or gross domestic product, is a measure commonly used to assess the economic output of a country that’s calculated by adding together all the services and goods produced in that nation over a period of time.

5 Ways to Prepare for a Recession

When the economy is in a recession, the stock market, jobs, economic output, and consumer spending all typically fall. At the outset, interest rates also frequently decline (the Federal Reserve may cut rates to spur economic growth), and the government’s budget deficit might increase over time due to lower tax revenues.

For the average person, a recession generally means sticker shock (higher prices due to inflation), job loss, pay cuts, and stock market losses. Read on to learn how to protect yourself financially when a recession is on the horizon.

  1. Eliminate credit card debt – While interest rates tend to fall initially during a recession, they might rise later as the government tries to slow down inflation. Even if rates are low, it can be challenging to qualify for loans because of strict credit requirements. Hence, it’s a good idea to pay down your credit card debt as much as possible beforehand to avoid paying more in interest later when rates go up. Plus, then your credit cards are free and clear for any unexpected expenses down the road.
  2. Build up your savings – You’ve probably heard it before, but we’ll say it again: you should establish an emergency fund that can cover three to six months of living expenses. This is particularly important if you’re expecting a recession. Then if any unexpected medical expenses or other emergencies pop up, you’ll be able to afford them when side hustles and other jobs may be scarcer.
  3. Consider investing in bonds – Some investments tend to be lower risk and more resilient during a recession, namely government bonds, gold, and other precious metals. As a recession approaches, talk to your financial advisor about whether it’s in your best interest to reallocate some of your investments.
  4. Avoid taking on new debt – A recession increases the risk that your pay might get cut or you might lose your job. With this in mind, it isn’t the greatest time to take on any unnecessary debt, especially if it’s a large loan for something like buying a car. If possible, wait to make these big purchases or pay in cash.
  5. Steer clear of ARMs – An adjustable-rate mortgage might seem appealing in the early days of a recession when interest rates are low. But there’s a good chance these rates will rise over time, leading to larger monthly payments that may become increasingly harder to pay during a recession, especially if you get laid off or lose a source of income.

The good news is that recessions don’t usually last very long – on average, 10 months. And it’s definitely possible to come out of them financially unscathed if you keep the above tips in mind and consult with a trusted financial advisor as needed. There’s no need to fear recessions – go into them informed and come out of them in a good place financially.