How to Prepare Your Finances For a Recession

Hi everyone, and welcome back to Melissa Making Cents!

CERTIFIED FINANCIAL PLANNERs™ end up being many people's one-stop-shop for talking and asking questions about anything loosely related to finances. We're the type of professional who is there for people in all situations, good or bad. It, unfortunately, seems like recently there's been an overabundance of bad (at least as far as expectations go). Yes, being a financial coach comes with a significant amount of responsibility. We're there to answer questions realistically, soothe fears, and taper expectations to reality. 

Unfortunately, one thing I can't do as your financial planner is predict the future – in fact, no one can, and if they tell you otherwise, they're more than likely attempting to sell you something.  .  That's one thing that's made the past two years extremely difficult for members of my profession. And just as it seemed the pandemic was slowing down, easing regulations that changed how we've lived our lives, it seems that something nasty has been brewing in the background. 

You've probably guessed by now that I'm alluding to the situation in Ukraine. While I'd obviously like to dive as little into politics as possible, it's challenging when those politics are hitting all of us so close to home. The combination of an economy slowed by a pandemic and pandemic-era regulations and war overseas resulting in historical sanctions has implications for all of us. Many are worried that inflation is ramping up to lead us into an economic recession. 

As I said earlier, and have said many times before, I can't predict the future. My grandmother loved the saying, "Even a broken clock is correct twice a day".  I cannot tell you whether all of this will lead to a full-scale recession or if it will stop at some temporarily elevated rate of inflation. I can, however, give you some advice, starting with a phrase that's near and dear to every financial planner and financial coach's heart – prepare for the worst and hope for the best. By following this philosophy, you'll rarely be caught off-guard, and will create the best possible scenario for yourself in just about any situation.

What IS a Recession?

The overarching point of this post is to discuss a contingency plan of sorts. Of course, it's essential to plan and prepare, especially in the face of what could be a recession. However, to get comfortable discussing what we should or shouldn't do in the face of an economic crisis, we should first discuss what a recession is. While I'm not going to go overboard or give any sort of grand lecture about economic cycles, inflation, recessions, or depressions – it's still essential to have a grasp of the basics.

Forbes states, "The National Bureau of Economic Research (NBER) is generally recognized as the authority that defines the starting and ending dates of U.S. recessions. NBER has its own definition of what constitutes a recession, namely "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."

For the most part – many of us won't necessarily realize if we're technically in a recession or not until we hear about it on the news. However, some key things will begin happening in recessions that we can use as indicators. During a recession, the cost of goods and services will increase, and people will lose jobs. The rising cost of goods and services lowers the purchasing power of our currency, the dollar; this is referred to as inflation.

Historical Recessions

Most recently, many of us experienced the hardship of the recession following the 2008 housing bubble. This time in history has come to be known as the great recession, which is a nod to the more serious great depression of the 1930s. The Great Recession was particularly bad and challenging for many Americans, many of whom experienced the real-life consequences of a high unemployment rate.

The seriousness of that recession and the potential for a new recession is a terrifying thought for many. However, while no recession is "a good thing," it can be stated that not every recession is as long and challenging as that one. In fact, recessions can come and go without many batting an eye. I'm not saying this to make light of the situation, just to reassure that all of this talk of inflation and recession, while not good, doesn't mean the end of the world.

What to do During or Before a Recession

As I said before, the best way to be ready for any situation is to prepare for the worst and hope for the best. That's why we're compiling some tips and tricks below that can ease the burden of potential future recessions. And while it's important to always try to follow these practices, the importance is even more significant when a recession seems like a possibility.

-         Get on Top of Emergency Fund

If you're not familiar with Emergency Funds, I'd highly recommend getting caught up by reading my article, Why an Emergency Fund Should Be a Part of Your Financial Plan. In it, I go over exactly what an emergency fund is and the best practices to quickly grow your emergency fund and why they're so important to have. I'll reiterate some of the points made in that article because I think they're critical in times of recession. Still, it's extremely comprehensive, and I'd suggest reading it nonetheless.

An Emergency Fund is exactly what it sounds like. It's a fund of money that you sit on if an emergency should come about. Other than an emergency – this account should be left untouched other than depositing money to grow it. The ideal emergency fund will have enough money to cover your household bills and expenses for at least eight to twelve months. However, there's no reason that your emergency fund can't or shouldn't be larger than that. If it seems like too big a reach remember that something is better than nothing.

In the case of a recession, an emergency fund will prove to be a handy tool to have in your financial utility belt! Should you or your spouse lose your jobs or have difficulty paying the bills because of rising costs, an emergency fund can step in and temporarily save the day.

• Don't Operate on Panic

One of the most common financial missteps people tend to make during a financial crisis or hardship is letting their lizard brain take the wheel. That is, in fact, the exact opposite of what you should do. During slowed economic times, it's ultra-important to make every move count, and you don't want to let a few problematic months or years undo all of your financial progress.

While you may want to consider restructuring or reorganizing your financial portfolio before or during a recession, completely pulling out of the market can be a terrible mistake to make. While people think of this as a way to "save" their investments from economic plunder, pulling out your money while prices are dropping could sell off all of your financial assets at a discount, which is a mistake you wouldn't forget when prices eventually begin to rebound.

-         Minimize Debts

Debt, especially with high-interest rates, can be tough to overcome during a recession. However, it's obviously almost everyone's goal to pay their debts and live a more financially-free lifestyle. So, if you have the available funds beforehand (without dipping into your emergency fund), you should consider paying off debts that will hold you back in recessions. This is honestly just good financial practice, but jobs can be sparse in recessions, and prices can rise. In that case, you'll be wishing you didn't have to pay out $100 here and $70 there.

-         Reassess Your Budget

When the economy is kicking and doing well, many of us get very loose with our budgets to the point where they essentially become non-existent. This means we end up having more credit card debt, less money in the bank, and less money in our emergency funds. Having and sticking to a good budget is one thing that you can do during a recession, or all the time, that can significantly impact your financial well-being.

During an economic crisis, our regular budget just might not do the trick. Therefore I would also recommend having a great emergency-budget plan ready to go before things ever get hairy. An emergency budget means that you already have a new structure to live your financial life by during an emergency. For example, in the blog post A Comprehensive Guide to Planning and Creating an Emergency Budget I say," A fact of life is that we occasionally get sick or hurt. If, for you, that were to mean not being able to work, having an emergency budget to restrict your spending will help you have as much time as you need to get back on your feet."

-         Consider Taking on Side-Jobs

With the structure of our economy in 2022, there's certainly an infrastructure for side-jobs. While no one usually wants to take on an extra job (especially doing something they feel overqualified for), don't necessarily count it out of the equation. There's NO shame in taking on an extra gig here or there when times are hard. Luckily, as I said, there is no shortage of jobs and gigs like this. Uber, Lyft, Ubereats, DoorDash, Instacart, and Postmates are some great examples of low-skill gigs that can be taken on to get some extra income during difficult times.

And while gas prices may be on the rise, don't let that stop you! Using your car during deliveries and to conduct business is an expense that can be written off at the end of the tax year, either by mileage or by saving receipts for gas.

-         Consider Rescheduling Vacations and Holding off on Large Purchases

It probably comes as a shock to absolutely no one that a recession or economic slowdown isn't the time for a vacation. If not because of the practicality of needing all the income you can get, there's also never a more critical time to remind your boss why you matter. You should also consider putting off large purchases during recessions, as you won't necessarily want to be making any extra monthly payments; however, this is a matter you should discuss on a personal basis with your financial advisor.

What NOT to do During a Recession

Now that we've talked about some easy things to do in the face of a recession or economic slowdown let's talk about some things not to do. I'll go into a little less depth on these points, as most of them are self-explanatory.

• Don't Take on Extra Debt

While we sort of touched on the subject before, it's worth reiterating that you probably don't want to take on additional debt during a recession, especially if it has a high or non-fixed interest rate.

• Don't Make Large Purchases

Discuss large purchases and financial decisions with your financial advisor beforehand. Typically, a recession isn't the time to be making any large home or auto purchases. However, each recession is different, and you should talk it out with your financial professional before you make any moves.

• Reconsider Financing Purchases

Sort of along the same lines as not taking on additional debt or making large purchases, you likely don't want to finance purchases during a recession. But, again, this comes back to the fact that money could get tight, and you don't want to be spreading your income over monthly payments if you don't have to. So my best advice is if there's something you really want, save for it instead of financing it (this is just good advice in general, really).

• Don't Change Your Investment Plan Willy-Nilly

People panic when they hear the word recession, which can lead to some silly actions taken by investors. Remember when everyone bought toilet paper at the start of the pandemic, which caused even more people to panic and buy out the toilet paper before we collectively realized that we'll live to wipe another day? The same thing happens on the market (kind of). Don't panic and sell off all of your financial assets before talking to your financial advisor; it could lead to you losing a lot of money, whereas if you'd held on long term, you likely would've gained all or most of your portfolio's worth back.

• Don't Give Up

During recessions, things will get stressful, but don't let that be an excuse to give up on yourself! Eventually, brighter days will come, and you'll be all the better for it. So during a recession or economic slowdown, take a breath and consider working on yourself in other ways that are relaxing and self-improving.

With things like YouTube and the internet – exercise classes are essentially free. So go on a walk, start trying to jog, start doing some yoga in your free time. Or even consider teaching yourself new skills that you can add to your resume!

Prepare for the Worst, Hope for the Best 

I started this article off by disclaiming I cannot tell the future. I can't say whether worse inflation or economic downturn is just around the corner. I don't want to paint a picture of doom and gloom, but I think it's a good idea to always make moves to recession-proof your financial plan. I also stick with my motto – prepare for the worst and hope for the best. 

If you or someone you know is interested in learning more about personal finance or how to prepare for possible economic hardships, please call or email to schedule an appointment with me. I'll work with you to create a financial plan that's optimized for you.

Until next time...this is Melissa Making Cents!

Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.