How to Prepare for a Recession

At any moment in time, there will be an expert predicting a recession.

(the CNBC Fed Survey puts the probability of a recession at 36%)

So don’t let the predicts spook you. The sky is falling for someone somewhere!

But if you are personally worried about a recession, there are things you can do to prepare.

The principle behind each of these suggestions is simple – the biggest worry in a recession is that you lose your job and are unemployed for a long time. To hedge against this, you have to increase your savings and have a cash cushion to weather that storm. The longer the better. When the situation changes and your worry subsides, you can invest the extra savings or use it to pay down debt.

Increase Your Emergency Fund

Your emergency fund is your first line of defense against any financial problem.

And one of the biggest financial problems is losing your job.

During a recession, the probability of that goes up. And the time it takes to find a new job goes up too. The Bureau of Labor Statistics keep track of this and this charge showed what happened after the Great Recession in 2007-2009. 20-22 weeks is a long time.

This is why the number one suggestion is to increase your emergency fund.

Most expert suggest an emergency fund that covers three to six months of expenses. If you’re concerned about a recession, increase that to twelve months of expenses. Twelve months is a long time but the time it takes to find a new job in a recession can be long too. You never know.

Then, put that cash in a high yield savings account so you’re maximizing the interest you’re earning while it waits (hopefully never to be used).

Avoid Big Purchases

Big purchases will either saddle you with debt or take a bunch chunk out of your cash savings – both of which are bad at a time when you think the economy may be shrinking.

If you must make a big purchase, try to make as small of a big purchase as you can. If you need a car, consider a used car that might not be as nice as you’d like. If you were thinking about buying a house, rent a bit longer.

If there is a recession, chances are you will be able to find yourself a good deal. Interest rates will come down, making mortgages more affordable, and your stockpile of dollars will be an asset.

💡 As a corollary, you can reduce the amount you’re paying to your debts as long as you’re banking the savings and those debts are relatively low interest. If you’re aggressively paying down high interest credit card debt, it’s safe to keep doing that because your worst case scenario is that you’d be charging more to your cards. If you have lower interest student or mortgage debt, it may make sense to save the difference for now in case you need it.

Continue to Save for Retirement

You may be tempted to reduce your retirement contributions. If you can avoid it, avoid it. At a minimum, ensure you get any company matches so you aren’t leaving any money on the table.

You want to continue saving for retirement because a recession may never come, or you may not be affected by it, and you want to ensure your goals in the future are still being pursued.

Be Realistic About Your Risk Tolerance

If there is a recession, the stock market will fall. The Great Recession is an extreme example but if you look at the list of stock market crashes and bear markets, it’s pretty gnarly (and there were a lot of “crashes” in the last few years that didn’t ring alarm bells here).

You may want to change your asset allocation if it will keep you up at night. Again, I don’t recommend making decisions based out of fear but only you know what you’ll be comfortable with.

If there’s a 10% correction, will you be OK? What about 20%? Or more? Be honest and adjust accordingly, but know that this is about avoiding panic and not because this is the best financial decision. (the market recovers within a few years after many recessions, crashes, and corrections)

If you want to feel better about it and can financially navigate the market falling, look at this chart from A Wealth of Common Sense. It shows the annualized return of the S&P 500 looking forward.

So if you look at the 2000 column, it returned (on an annual basis) -9% after one year. -11% after two years. But by year 7, it had recovered enough that you had a 1% annualized return for each of the prior 7 years (so it more than recovered).

The point of this chart is how little red there is and how quickly things recover. Use it to calm yourself, it’s what I do. 😁

Start or Update Your Budget

If you don’t budget at all, a free budgeting tool can make this really easy.

When times are good, not knowing where every last dollar goes isn’t as critical. When times get tougher, you want to batten down the hatches and make sure your budget is tight. No wasted dollars that could be put into your emergency fund.

Also, if you lose your job, you will know where to cut expenses ahead of time.

Review Your Emergency Plan

We know about emergency funds but have you create an emergency plan? It’s a fire drill for potential emergencies, like losing your job, which are easier to make when your house isn’t on fire yet.

What will you do if you lose your job? Where do you go to file for unemployment? Where will you submit your resume? Have you updated it?

Is there anything you can do right now that may help your prospects in the future? Does that mean attending networking events or learning how to find a job today?

What if you’re out of a job for longer than the number of weeks your state offers unemployment benefits? Will you do side gigs? Is that driving for Uber or Lyft, maybe delivering for Doordash, or finding some other side hustle? Set some of those things up now (and perhaps give them a try to see if you’d even like them, the extra cash can go towards your savings).

Preparation is Power

By preparing for a recession, you don’t lessen the probability it happens or that you lose your job, but it puts you in a better position to navigate it if it happens.

And if it doesn’t, now you have extra savings that you can put towards your other goals or invested in your future.