How to recession-proof your finances

In the wake of the COVID-19 pandemic, the stock market and economy appear to be stronger than ever for some time. Then inflation started to rise. What goes up must come down, and now we are suffering the double whammy of post-pandemic economic woes and new geopolitical issues like the energy crisis.

If you’re worried about a recession coming soon, you’re not alone. 74% of US consumers are thinking the same thing, and experts echo their concerns. More than two-thirds of economists expect a recession to hit the country in 2023, with some believing it could come earlier.

“We are in or currently going through a recession,” said Howard Dvorkin, a certified public accountant, financial writer and chairman of Debt.com. “When the government cuts domestic oil production, it raises gas prices the next day.”

Hard times may come, and there is nothing we can do about the broader macroeconomic conditions the world may face over the coming months and years. However, we can take measures to protect our own money.

What to expect from a recession

For many, a recession means a “financial crisis” or a general sense of panic rather than a specific set of circumstances. But among experts, a recession has a precise definition. According to the National Bureau of Economic Research (NBER), a recession is “a significant decline in economic activity that permeates the economy and lasts for more than a few months.”

Although disputed by some, this definition is still widely used, and is our first clue to understanding how we should treat our money in these challenging times. When a recession hits, we can expect four broad effects:

  1. Low economic growth
  2. unemployment
  3. low wages
  4. Asset prices fall
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The first is in the definition of a recession and can result in companies going bust or struggling to scrape by. As a result, rising unemployment is a natural consequence as jobs disappear. Low labor supply and high labor supply (due to unemployment) lead to low wages. And as average consumers have reduced spending power (due to lower wages) and businesses suffer from weak growth, most asset prices fall, including company stocks and property.

This is a simplification, and every recession is a little different, but we should expect something roughly along these lines. So, now that we’ve established what you need to prepare, what can you do to protect yourself?

Limit unnecessary spending

You can’t control your wages, whether your employer loses or if you become unemployed, but you can control your own expenses — and often more than you realize.

The first step to cutting back is to track what you’re actually spending your money on and identify areas you can cut back on.

“There’s always 15% of the budget cut,” says Dvorkin. She advises that limiting big-ticket spending will have the most impact, but recommends starting small, cutting back on things like going out for lunch or coffee.

Another place to check is subscriptions. Between streaming, news and delivery, it can be surprising how much a $5-to-15-per-month commitment adds up, as Million Stories Media discussed in a recent TikTok.

Then, use your results to create a budget. Personal finance expert Erin Lowry recommends something she calls a “bare essentials” budget, which involves removing all unnecessary items to help you determine how much you need to have each month. Then you can later refine it to be less strict.

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If all of this seems too time-consuming or difficult to figure out, there are plenty of apps that can help. Some automatically sync to your bank account to help you track spending, while others record whether you’re sticking to your budget or even automate your savings.

Create an emergency fund

When you start spending less, you can use what you save to build yourself a safety net.

“Cash is king,” says Dvorkin. “People need liquid funds for emergencies. Try to save three months of living expenses to start with, ideally six months, but that’s hard for most people.”

Some experts recommend saving more if your income is unstable, such as if you’re self-employed. You may find that the number you need to save to cover several months of living expenses is overwhelming, so it may help to start with a lower goal. Even $1,000 is better than $0.

Once you build your emergency fund, you’ll have money to draw on when needed. For example, you can use your emergency fund for living expenses if you lose your job, unexpected medical expenses, or a replacement boiler if yours breaks down.

Since asset prices tend to be volatile during a recession, it’s best to keep money in a liquid savings account. Assets like investments and property are not true emergency funds.

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Be careful with investments

If you have a healthy emergency fund to cover when times get tough, you’re at a point where you can think about investing (if you want to). However, if you prefer not to risk your money or you plan to spend the money on a major purchase in five years or less (eg, a new home or car), then it’s best to stay away.

Investment values ​​fluctuate at the best of times, and since asset prices typically fall during recessions and many companies go bust, this is a particularly risky time to invest. It is not for the faint of heart. If you want to invest, it’s best to first talk to a financial advisor, who can advise you on how to diversify your investments in accounts like a 401(k) or IRA.

Also, many people choose low-risk investments, such as government bonds. They may not have the most impressive returns, but they are historically less likely to crash and burn.

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In the past, gold has gained a reputation as a “safe haven” asset because its price tends to rise when others fall. However, there is no guarantee that this pattern will continue in the future.

Overall, the best way to “recession-proof” your finances is to stick to the things you have control over: reduce your spending, prepare for the worst, and make sure you have plenty of liquid cash to cover you in an emergency.

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