Recent signs that a recession is coming have had Americans panicking. President Donald Trump recently stated that a recession will only occur if voters fail to reelect him in 2020, but about one-third of economists agree that the dreaded “R” word is on the horizon no matter what — and likely to arrive by the end of 2021.
Though no one can predict exactly when a recession will occur, one thing is true: Recessions are a cyclical component of the economy, and another is bound to happen at some point, whether one or 10 years into the future.
So what exactly is a recession and how can you protect your finances during the next one?
A recession is defined as a period of significant economic downturn that lasts longer than two consecutive quarters. Usually, economists look to the gross domestic product as the primary measure of economic health. However, the National Bureau of Economic Research ― the committee that officially declares and measures recessions ― says a negative GDP doesn’t necessarily have to occur to call a recession.
When it comes to shoring up your savings and investments against a recession, it’s important to understand that no one is 100% immune to its effects.
“Everyone is subject to risk,” said Justin M. Owen, a registered investment adviser representative and owner of Owen Financial Planning. “The best safeguard someone can have in place during a period of recession is a professional retirement plan that is goal-based.”
That’s because a 25-year-old with an aggressive investment plan is going to ride out a recession much differently than a 60-year-old whose top goal is avoiding financial loss. “A retirement plan should take into account timelines, ages, risk tolerance and so much more,” Owen said. “You should know what your portfolio is going to look like during a severe market downturn so that you fully understand what real risk looks like.”
“The best safeguard someone can have in place during a period of recession is a professional retirement plan that is goal-based.”
– Justin M. Owen, registered investment adviser representative
That said, there are a few steps you can take to minimize losses during a recession, no matter your age or financial goals.
1. Understand your cash flow.
The first step in preparing for an economic downturn is knowing where you stand. An easy way to do this is calculating your cash flow, or how much money you have coming in versus going out.
“Uncertainty is a major cause of financial stress, so understand what your cash flow looks like in a typical month, and some of that uncertainty will be removed,” said Ian Bloom, a certified financial planner and owner of Open World Financial Life Planning. “If you lose your job or if the revenue slows down in your business, you may feel less constrained if you know how many months your savings will last you.”
There are a number of free tools available to help you figure out this number, such as Mint. Simply link your accounts, and the free software will track all your transactions and categorize them.
“You will see patterns emerge, like more ‘fun money’ spending in summer months or around holidays, but you will also see the consistent ‘needs’ of the household and know what it costs to keep yourselves going when you need to be lean,” Bloom said. You can then set specific budget goals and look for ways to cut costs or increase savings.
2. Have a fully-funded emergency fund.
One of the best defenses against any unexpected financial strain is an emergency fund. During a recession, you can tap into that fund rather than rack up high-interest debt.
Owen suggested having at least three to six months’ worth of living expenses set aside, preferably in a high-yield savings account. “It is not to be touched for any reason other than a true emergency,” he said. For example, if you are laid off ― a strong possibility during a recession ― you would have enough liquid money to keep you afloat for a while. Building your emergency savings “is priority one and takes precedence over all else. You should constantly be working to fund this until you have reached the amount you need,” Owen said.
3. Get rid of debt.
Once you’ve built up an emergency fund, your next priority should be paying off as much debt as possible.
If money becomes tight, you’ll want your income going toward basic living expenses and not paying back lenders. Plus, if you wind up missing payments, it will wreck your credit score and make it tougher to get approved for new credit once the economy recovers, according to Lindsay Martinez, a certified financial planner and owner of Xennial Planning LLC. She recommended focusing on high-interest debt first, such as credit cards and private student loans.
4. Review your asset allocation.
You’ll also want to be sure that your current asset allocation, or mix of investments, matches your risk tolerance and retirement goals. If you’re close to retirement age, for example, you might need to make your investments more conservative in preparation for a possible recession. “The 80/20 stocks-to-bonds mix is sure to go south, and it becomes nearly impossible to make up for those lost dollars,” Martinez said.
On the other hand, if you’re in your 20s or 30s, you still have decades to make up any losses and can afford to ride out the storm with a more aggressive portfolio. In fact, a recession is a great time to buy up more securities at rock-bottom prices if you can.
5. Update your résumé.
Unfortunately, even the most dedicated employees are at risk of being laid off during a recession. In 2008, during the height of the Great Recession, 2.6 million Americans lost their jobs ― the highest level in more than six decades. Those at the highest risk of becoming unemployed are young college graduates.
“Brush up on your job skills and keep your resume up-to-date,” Martinez said. “In the unfortunate case of a job loss, you are ready and poised to showcase your talents and stand out among the thousands you may be up against.”
6. Stick to your plan.
It’s important to understand that recessions do happen. All you can do is prepare as best you can. The key is not to panic when markets take a nosedive and undo that planning. By selling at the bottom of the market, you will miss out on the opportunity to gain back those losses as the economy recovers.
“In the most recent recession, the S&P 500 began dropping at the end of 2007 and began recovering by mid-2009,” Bloom said. “Recessions can be dramatic, but even in the most dramatic example from recent history, we see the market climbing back up within two years.”
Of course, this doesn’t mean that all future recessions will behave the same way, but historically, they’re briefer than we tend to remember.
“Whatever investment strategy you chose before the recession will likely remain functional after the recession,” Bloom said. “Just because things look bad momentarily doesn’t mean they will be bad forever.”