Katherine Gustafson is an author and personal finance expert from Portland, Oregon. She writes about investing for Wealthsimple as well as having written for Forbes, Business Insider, TechCrunch, and LendingTree. Katherine is a past recipient of the Izzy Award for outstanding achievement in independent media. She has a BA from Amherst College and an MA from Boston University.
While we like to talk about “the economy” as if it’s a static entity, it’s actually more like a living, changing ecosystem. It fluctuates unpredictably, sometimes wildly, and can look very different from one year to the next.
That’s why the threat of recession is always with us. And while the timing is usually an open question, we know it’ll never take as long as we’d like for the next one to hit.
Some experts think one may be coming soon. Close to 50% of U.S. chief financial officers responded to a recent survey saying they think the U.S. economy will face a recession sometime this year. And an overwhelming majority—80%—believe it will hit before the end of 2020.
What is a recession?
A recession is often defined as two consecutive quarters in which an economy shrinks. According to the century-old nonprofit National Bureau of Economic Research, a recession can be identified by clear signs and symptoms. The organization defines a recession as “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.”
This definition makes clear that recessions are extremely disruptive to people’s daily lives and financial fortunes, causing everything from layoffs and unemployment to rising prices and shortages.
All of these effects were in evidence during the Great Recession of 2008, the worst economic downturn in living memory.
Some of these effects may show up in certain parts of the economy during what may be termed “mini recessions,” wherein economic growth slows but doesn’t entirely stagnate or reverse. In 2015-2016, for example, the U.S. economy went through this type of slowdown; with economic growth still positive and a falling unemployment rate on a national level, the period didn’t meet any usual definition of a recession, but the energy and agricultural sectors, and manufacturers who supply them, felt the pain as those particular industries struggled with a downturn.
Can we predict recessions?
As much as we’d like to be able to anticipate each recession, it’s difficult—if not impossible—to know when one is coming. Even seasoned economists aren’t good seers on this subject. Witness the May 2007 prediction from then-Federal Reserve Chairman Ben Bernanke that mortgage defaults wouldn’t do major harm to the U.S. economy. That prognostication aged terribly.
There are some indicators that experts use to sniff out a change in the financial winds that may lead to a recession. A prominent one is an “inverted yield curve,” which means that short-term bond rates are higher than long-term bond rates. While long-term rates are usually higher, these sometimes switch places before a recession hits. If you start hearing this term in the news, it’s best to start getting your finances recession-ready.
Just as it’s tricky to predict recessions, it’s also near-impossible to know how a recession will affect you personally. A recession won’t necessarily decimate the value of your investments or result in you getting laid off. You may see rising prices, but it’s hard to know if those will affect the things you typically buy.
Some people may skate through a recession unscathed while others feel deep financial pain. These things are inherently unpredictable, just like the market itself.
How to prepare for a recession
Being prepared for a recession essentially means being ready to care for yourself and your family financially if your current situation is forced to change. Here are some specific recommendations:
Build your emergency fund
The number one thing you can do to prepare yourself for the next downturn is to save up a substantial chunk of money to serve as an emergency fund. Experts recommend keeping 3-6 months of living expenses in a high-interest savings investment account. This money should be sacrosanct; only to be touched in the event of an unexpected emergency like losing your job or having your hours at work severely curtailed.
A recession can compound the difficulty of losing a job because not only are you out your usual income but a sluggish economy may make it hard for you to get hired again at a similar salary. When you do find new work, you may be forced to take a pay cut or work more hours for the same pay, which will result in financial pressure unless you have savings to make up the difference.
Examine your expenses
Considering that an emergency fund will only go so far to support you in the event of a job loss or pay cut, it’s good to make sure you’re living as lean a lifestyle as possible before the worst actually happens.
Make it a habit to sit down with your family and examine your spending to find areas where you can tighten your belt. Some items that may be on the chopping block are eating out, expensive clothes or gifts, extra spending on hobbies, and vacations.
Pay down debt
Working to pay down debt when the economy is booming is like doing your future self a favor. You can start paying extra capital while things are good to pay your debts off faster. You could consolidate loans to get a lower average interest rate or enter credit counseling if your debt is a burden. Getting your debt payments under control is essential, since having good credit will help you weather future financial storms.
A popular way of paying down debt is the “debt snowball” method, which involves paying off your smallest loans first to give you some early wins that can motivate you to tackle your bigger loans. Another option is the “debt avalanche” method, which has you pay down your debts with the highest interest rate first, no matter its size, and work your way down to the lowest-interest loan.
Gain employment and side-hustle skills
One of the major concerns people have about recessions is the potential for job loss. Layoffs are common when the economy takes a nose-dive, and getting a new gig can be tricky when no one’s hiring. One good thing to do while the economy is healthy is to pick up some in-demand skills or credentials to make yourself more attractive on the market in case you need to look for a new job in a down economy.
Another option is to pursue skills that can be done as a freelancer so you’ll be able to find smaller jobs as a stopgap if your main income source dries up. Once you’ve got those skills, you can use them as a side hustle to earn extra income that you can stash away in your emergency fund or use to pay down more of your debt.
Set up access to additional credit
Along with recession-proofing your job skills, it can be a good idea to enhance your financial resources for potential future need. You can access additional credit through a home equity line of credit or some new credit cards with higher limits. Keep those resources open and don’t use them before you have to.
If you have credit card debt already, it is a better idea to pay those down as fast as you can to free up credit than to apply for new credit cards. Consolidating your credit card debt using a personal loan that allows it is another good way to increase credit flexibility while also reducing your average interest rate.
Before a recession hits, review your investment portfolio to ensure that it fits the level of risk you’re comfortable with. How much risk you will want to take on depends on your attitude and personality as well as where you are in your life; those near retirement will want to be far more conservative in their investments than younger people.
Once you’ve adjusted your investment risk, don't stop investing during a recession. The market will almost certainly go up again, so it's not prudent to yank all your money out at the first sign of trouble. Consider staying the course and buying shares of a diversified asset mix even when the market falls.
If you take all this advice you’ll be in the best position possible when the next recession comes along. Boosting your financial stability and flexibility should be the centerpiece of your personal recession-proofing.
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