How to Prepare for a Recession

By Eric Reed

This one is happening.

We might get lucky. The coronavirus pandemic might burn out quickly, or policymakers might soon decide that it wasn’t as serious as they thought. The government might enact economic relief on a scale equal to the scope of the coming problem, propping up individual incomes and business losses throughout the declared national emergency. All of this might happen, and it might work.But the more likely reality is that the long-awaited recession is probably almost here. American businesses are closing and laying off employees on a massive scale, and the stock market is reeling. We’re already firmly in bear market territory, and a recession seems to be inevitable. The only question is, how should you prepare for it?

This is at once the easiest and hardest piece of advice when it comes to recession-proofing your finances.

Easy, because of course you should save money. It takes no special insight to tell you that having more money will make life less difficult during troubled times. It is still the best single thing you can do for yourself, though. If at all possible, start saving up now.

The average financial wisdom suggests that individuals should have a runway of about three months; that is, you should have enough on hand to cover three months’ worth of expenses. During the Great Recession it took people longer than that to find work, with many people jobless for six months or more. Your goal should be an emergency fund that plans for the realistic worst.

Save up with the target of having six months’ worth of cash on hand, money that could cover the costs of rent, bills and basic necessities. This is how long it might take you to find new work in a recession, so this is what you want to plan for.

Of course, this is also the hardest piece of advice when it comes to financial planning. And of course “have more money” is the solution to financial problems. It’s worth making this a priority, but the truth is that large, excess savings are a luxury that simply not everybody can afford.

The biggest problem during a recession is layoffs. Yes, the market tanks and business development slows down. For the average consumer, though, the No. 1 fear is simply losing their job.

So start looking for a new job now, before you lose your other one.

Looking for a new job doesn’t have to mean actively sending out cover letters. Finding a job is a process. It means networking, meeting people, rebuilding old relationships and trying to find opportunities. It means paying attention to your skills, seeing where you might have gotten rusty or what might make your resume more impressive. It means looking seriously for growing job markets and new places you could take your career.

All of this takes time, and the worst moment to start is after you’ve been laid off. Instead, start now. If your job is safe, you’ll have shared a few cups of coffee with people worth knowing and brushed up on a new language. All useful things.

If not, though, you’ll be ahead of the game.

During a recession one of the hardest pieces of personal finance to manage is debt. This is because it’s largely intractable. People with student loans can take advantage of some hardship-based programs, but other than that most debt remains a constant during good times and bad.

So take stock of it now. What do you owe, and where? What is your high interest debt? What are your monthly payments? Especially, what do you owe on credit cards?

The next step is deciding what to do with it. Look at options for restructuring to lower cost accounts, or consolidating your debt to a more manageable form. Ideally, you want to pay off your high interest debt to make sure that it isn’t hanging around your neck if you lose your job. But don’t simply throw money at the credit card. You’ll also need your cash reserves going into a recession, so strike a balance between paying off your loans and keeping some money on hand for rent.

Perhaps the most difficult single exercise in personal finance is a monthly budget, which is why most households don’t keep one.

That isn’t to say that most people don’t know what they’re spending. From that perspective, the average consumer absolutely budgets. Most households keep a general monthly sense of how much goes in and goes out. They get sloppy, however, around the details.

You want to go through your finances with a fine tooth comb. How many websites are you subscribed to? How many of those do you actively use? How many memberships do you pay for places you no longer visit? How much money do you actually spend at the bar every month, and the same for groceries and entertainment and those over-priced lattes?

A detailed monthly budget is good financial housekeeping for any era, but in a recession it can be absolutely critical. It will let you know where you can find some money every month, and the areas that might let you cut back.

The truth is, if you’re like most people, you spend more every month than you realize. That’s good news. It means there’s some money to find.

It’s not necessary to stop investing during a recession, but it should be done with extra caution. Consider core sector stocks and dividend stocks. Also, avoid volatile sectors like energy, oil service, commodities and financial shares. Stocks of consumer discretionary companies, those that offer non-essential items such as apparel, luxury goods and consumer services, are also prone to volatility during a recession.

Make sure that your asset allocation has a large cash portion and develop passive streams of income. Peer-to-peer lending and real estate investment trusts are two ways to create an income stream.

Most importantly, don’t try to time the market. It may be tempting to buy the dip and reap returns, or sell off your equities and wait for a return to normalcy. But the former risks greater losses and the latter risks missing out on the recovery. You’re better off sticking with your existing long-term investing plan.

• Consider talking to a financial advisor about how to ride out a financial downturn. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
• It’s important to be able to distinguish between a market correction, a recession and a depression.
• Consider taking out a home equity line of credit as a ready source of funds should your savings be depleted.

Photo credit: ©iStock.com/D-Keine, ©iStock.com/Gwengoat, ©iStock.com/ljubaphoto

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