How to protect your finances from the recession

In the wake of the COVID-19 pandemic, the stock market and economy seemed to continue stronger than ever for a while. Then inflation started to skyrocket. What goes up must come down, and now we are being hit with a double whammy of post-pandemic economic woes and new geopolitical issues, such as the energy crisis.

If you’re worried a recession is coming, you’re not alone. 74% of US consumers think the same, and experts echo their concerns. More than two-thirds of economists expect a recession to hit the country in 2023, and some believe it may come sooner.

“We are in a recession or headed for it,” says Howard Dvorkin, certified public accountant, financial author, and president of Debt.com. “When the government cut domestic oil production, it raised gasoline prices the next day.”

Difficult times may be ahead, and there is little we can do about the broader macroeconomic conditions the world may face in the coming months and years. However, we can take steps to protect our own finances.

What to expect in a recession

For many, a recession means “financial crisis” or a general sense of panic rather than a precise set of conditions. But among experts, a recession has a precise definition. According to the National Bureau of Economic Research (NBER), a recession is “a significant decline in economic activity that spans the entire economy and lasts for more than a few months.”

Although disputed by some, this definition is still widely used and is our first clue to understanding how we should treat our finances during this challenging period. When a recession hits, we can expect four broad impacts:

  1. lower economic growth
  2. Unemployment
  3. lower wages
  4. Falls in asset prices

The first is in the very definition of a recession, and can result in businesses failing or struggling to get ahead. As a result, rising unemployment is a natural consequence as jobs disappear. A lower supply of jobs and a higher supply of labor (due to unemployment) translates into lower wages. And as average consumers have reduced purchasing power (due to lower wages) and businesses suffer from poor growth, most asset prices fall, including corporate stocks and property.

This is a simplification, and every recession is a little different, but we should expect something along these lines. So now that we’ve established what you need to prepare for, what can you do to protect yourself?

Limit unnecessary expenses

You may not be able to control your wages, whether your employer goes bankrupt or you become unemployed, but you can control your own spending, and often more than you think.

The first step to cutting back is to track where you’re actually spending your money and identify places you can cut back.

“There is always 15% of the budget that can be cut,” says Dvorkin. He cautions that limiting major expenses will have the biggest impact, but recommends starting small, such as cutting back on things like going out for lunch or coffee.

Another place to look is subscriptions. Between streaming, news, and deliveries, it may surprise how much multiple commitments of $5 to $15 per month add up, as Million Stories media discussed on a recent TikTok.

Then use your findings to make a budget. Personal finance expert Erin Lowry recommends something called a “basic essentials” budget, which involves cutting out everything that’s nonessential to help you determine how much you really need to get by each month. She can then refine it to be less strict later on.

If all this seems too slow or difficult to understand, there are many apps that can help. Some automatically sync with your bank account to help you track spending, while others track whether you’re sticking to your budget or even automating your savings.

Create an emergency fund

As you start to spend less, you can use what you save to create a safety net.

“Cash is king,” Dvorkin says. “People need liquid funds for emergencies. Try to save three months of living expenses up front to start, ideally six months, but this is difficult for most people.

Some experts recommend saving more if your income is volatile, such as if you’re self-employed. You may find that the amount you would need to save to cover living expenses for several months is so high that it is demotivating, so it may help to start with a lower goal. Even $1,000 is better than $0.

Once you build your emergency fund, you’ll have plenty of money to use when needed. For example, you could use your emergency fund to pay for living expenses if you lose your job, unpredictable medical expenses, or a replacement furnace if yours breaks down.

Since asset prices tend to be volatile during a recession, it’s best to put the money in a liquid savings account. Investments and assets like property are not true emergency funds.

Approach investments carefully

If you have a healthy emergency fund to back you up in case times get tough, you’re at a point where you can think about investing (if you want to). However, if you’d rather not take chances with your money or are planning to spend money on a big purchase in five years or less (for example, a new house or car), it may be best to steer clear of this.

The value of investments fluctuates at best, and since asset prices often fall during a recession and many companies go bankrupt, it’s an especially risky time to invest. It is not for the faint of heart. If you want to invest, it’s best to first talk to a financial advisor, who can advise you on making diversified investments in accounts like 401(k)s or IRAs.

Also, many people opt for lower-risk investments, such as government bonds. They may not have the most impressive returns, but historically they are also less likely to crash and burn.

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In the past, gold has earned a reputation as a “safe haven” asset, as its price tends to rise when others fall. However, there is no guarantee that this pattern will continue in the future.

In general, the best way to protect your finances against recession is to stick to what’s in your control: reduce your expenses, prepare for the worst, and make sure you have plenty of liquid cash to cover you during emergencies.

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