The next recession is on the horizon. That statement is true now, it was true a year ago, and it will still be true in 10 years. Perhaps the famous Benjamin Franklin quote should be updated to say the only certainties in life are death, taxes, and recessions.
While recessions are part of the natural cycle of the economy, they are notoriously difficult to predict. It is usually only after a recession has started that economists actually know about it. The economy is usually in a full upswing before anyone realizes the recession is over.
Regardless of when the next one will start or end, if you don't know how to prepare for a recession, it can be scary to think about. The last recession in 2008 was a particularly hard-hitting one, especially for the Millennial generation who were entering the workforce and faced the prospect of waiting months or even years with finding a job.
But fortunately, there are some simple and concrete steps you can take to prepare for the next recession, whenever it arrives. By having a plan in place, you can soften the blow of a recession or even profit from it.
Table of Contents
- 1 10 Things to Do Before the Next Recession
- 1.1 1. Don't Panic
- 1.2 2. Increase Your Cash Reserves
- 1.3 3. Pay Off High-Interest Debt
- 1.4 4. Take Out Additional Lines of Credit
- 1.5 5. Live Within Your Means
- 1.6 6. Reconsider Big-Ticket Purchases or Sales
- 1.7 7. Recession-Proof Your Job
- 1.8 8. Start a Side Hustle
- 1.9 9. Don't Try to Time the Market
- 1.10 10. Adjust Your Asset Allocation to Match Your Risk Tolerance
- 2 How to Prepare for the Next Recession
10 Things to Do Before the Next Recession
1. Don't Panic
First things first, don't panic.
During good economic times, the unemployment rate hovers around 4%. In the 2008 recession, unemployment peaked at 10%. So while 6% of people who were employed lost their jobs, 90% stayed employed.
Preparing for a recession doesn't mean stocking up on canned goods and preparing for the apocalypse. In most cases, the economy stops growing or retracts slightly. If you have a long term view of your investments and your career outlook, weathering a recession is certainly doable.
The people who fared the worst in the last recession were those that were over-leveraged on their houses, in debt, and had more bills to pay than the income coming in.
If you have a safety net and are making wise decisions with your finances in the good times (more on that below), a recession is more like a speed bump than driving off a cliff.
2. Increase Your Cash Reserves
Most financial advisors recommend having at least 6 months of expenses saved up in an emergency fund. This will allow you to continue paying for the necessities such as rent, food, and utilities should you lose your income for a period of time.
Sure, you can cut things like vacations or a new car. But you will need some cash to stay afloat even after tightening your belt.
If you're not sure where to start, begin by tracking your expenses. Take a long, hard look at what you really spend every month by going through your credit card and bank statements. Then multiply that monthly number by 6 and make a goal to set that aside in a safe place.
It may seem like a daunting number, and that's ok. It could take a year or more to save up, but if you can put aside a portion of your income every month in good economic times, you are well on your way to reaching your goal.
If you're really serious about building up your emergency savings, you could find ways to make some additional income every month that would go straight to savings. Even just learning how to make an extra $500 a month can be the difference you need to reach your goal months or even years sooner than planned.
One thing to note is that your emergency fund should not be invested in Bitcoin or the next hot tech stock. You want to access this money immediately if necessary and rely on it to stay relatively stable in value.
While the 2% returns on a high yield savings account are not sexy, remember this is for short term needs. In a recession, the stock market is generally one of the first things to plummet, and if you have your supposed safety net invested there, it could get wiped out in a matter of weeks or months.
Also, consider building a collection of passive income streams to assist your cash flow. Passive income is continuous income without devoting much time and resources (once the process is established).
3. Pay Off High-Interest Debt
While increasing your emergency fund, you should also be equally diligent in paying down debt. Almost all Americans have some form of debt, whether it be a mortgage, car loan, student loans, or credit cards.
When used responsibly, debt can be a great tool. With the record-low interest rate environment we've enjoyed the past several years, taking out a mortgage to buy a home or even learning how to invest in real estate with little money down can be a great boost to your financial stability.
However, debt payments can be troublesome during a recession when finances are tighter, especially if they are high-interest consumer debt. When you may be trying to cut back on your lifestyle, credit cards with 15-20% interest rates can make saving money seem impossible.
While it's never a good idea to rack up thousands of dollars in credit card debt, if you do have high-interest debt, now is the time to pay it down before a recession aggressively.
4. Take Out Additional Lines of Credit
This may sound like a contradiction to the last point to pay off your high-interest debt but stick with me.
There's a saying that the easiest time to get a loan is when you don't need it. And that is very true. Banks love to lend money to people who have good credit, high incomes, and lots of liquidity.
If you are thinking of refinancing your mortgage or taking out a HELOC (home equity line of credit), or even a business loan, now is the time to do it. Generally, during an economic downturn, lending requirements tighten significantly. Even if your financial situation hasn't changed, it can be much harder to get a loan.
To the previous point, now is not the time to go out a buy a brand new car or open a high-interest credit card to go on a shopping spree. But if you are taking out low-interest debt responsibly or want to have a line of credit in place as a backup plan to an emergency fund, it is much easier to do so now than after the next recession begins.
5. Live Within Your Means
This is good advice whether you're preparing for the next recession or not, but it is essential in the face of economic uncertainty.
Spend less than you earn. It's easy to say but often hard to live by. If you're spending money you don't have now in the good times, it will only get harder when finances get tighter.
If this has all started to sound like a broken record, it's because personal finance at it's most basic is pretty simple:
- Spend less than you earn
- Save for a rainy day.
- Don't buy the stuff you don't need with money you don't have
Learning to live within your means is not something that happens overnight. It's a habit developed and practiced over time, like exercise for your wallet.
If you can work on your mindset around money now, before potential disaster strikes, you have a much better chance of being prepared for any storm that comes your way.
6. Reconsider Big-Ticket Purchases or Sales
When it comes to preparing for a slowing economy, one thing you don't want to do is take on a huge financial burden. Now may not be the time to buy that new car or bigger house at the top of your price point.
Conversely, if you're looking to sell a big-ticket item shortly, such as your house, now may be the time to do it. If the economy falters, the housing market could slow as well, and you could have a much harder time selling. And if you get into financial trouble or an unyielding timeline, you could end up taking a loss if you wait to sell until after a recession starts.
7. Recession-Proof Your Job
In the past few years, unemployment rates have dropped to record lows, and employees have enjoyed a lot of bargaining power. Many industries have shortages of skilled workers, and it has been easy to jump from one company to another to get a promotion, pay raise, or better benefits.
During a recession, all of this can come to a screeching halt. As companies cut back budgets and look for ways to reduce expenses, one of the first things to scrutinize is the employee base. People are afraid of losing their job, so they hold onto it instead of looking for something new, so fewer positions become available.
Another consequence of this is a “last in, first out” mentality. If you're the newest person on the team, you may not have had time to prove your worth or network within the company to secure your position.
As we approach the next recession, it may be wise to think twice about making a big career move and perhaps consider staying in a job where you've proven your value. There are no guarantees in life, but having a strong network of colleagues that support you and tangible results of the work you've done could shield you from the next round of layoffs should they occur.
8. Start a Side Hustle
When money gets tight during a recession, having even a small income stream coming in can help offset a loss in income and help pay the bills.
Whether you have a hobby like woodworking you can turn into a side income or taking on freelance projects in your spare time, there has never been an easier time to learn how to make money from home and bring in extra income outside of your day job.
Don't wait until you desperately need the money to make ends meet. It can take some time to build a solid income stream.
Here are a few tips for identifying a side hustle that will work for you:
- Make a list of your unique abilities. Or better yet, ask those around you what they think your unique skills are.
- Find someone who needs your skills. For example, if you are an accountant by day, you could help a small business owner who is great at selling his products but not so good at keeping up with the finances. You can teach him how to become a bookkeeper for his own business or even do the bookkeeping for him as a side hustle.
- Take advantage of the gig economy. There are so many ways to make money in the gig economy – whether driving for Uber, delivering groceries, or even pet sitting.
9. Don't Try to Time the Market
So far, we've looked at many practical ways to increase income, pay off debt, and generally survive day-to-day in a recession.
But another often-overlooked aspect of preparing for a recession is making sure your long term retirement investments are secure. Many people try to do is time the market – sell when stocks are high, and buy back in at a low point.
The only problem is that buying and selling is often an emotional decision, and the risks are extremely high. Even Warren Buffett, one of the greatest stock-pickers globally, thinks it is a huge mistake to try to time the market.
It can be tempting to try to predict a crash and get out before it happens. Still, in fact, multiple studies have shown that investors who try to time the market almost always end up under-performing versus a buy-and-hold index strategy over time.
10. Adjust Your Asset Allocation to Match Your Risk Tolerance
While trying to time the market is generally not a wise move, that doesn't mean you shouldn't buy and sell to reallocate your portfolio from time to time.
With the stock market's meteoric rise over the past 10+ years, now is a great time to look at your asset allocation and see if it matches your risk tolerance.
For example, if you will be entering retirement in the next year or two but have a majority of your investments in equities, it may make sense to move some of that money over to less risky investments that have a better chance of holding their value in a recession.
If you are fresh out of college and have a 40-year career ahead of you before you need to access your retirement savings, then a heavier allocation of stocks may make sense.
Either way, you should consider your time horizon and risk tolerance and adjust your investments accordingly.
How to Prepare for the Next Recession
I wish I had a crystal ball to predict when the next recession will begin, but unfortunately, no one can know for certain.
There are certain metrics we can watch that are indicators for a possible recession. But as the great economist Paul Samuelson once quipped, “the stock market has predicted 9 of the last 5 recessions”.
Regardless of when the next downturn occurs and how severe it is, you will be prepared for whatever happens by taking these 10 steps to take control of your finances.