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9 WAYS TO PREPARE YOUR FINANCES FOR A RECESSION

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8 minute read Published August 18, 2022

Written by
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Edited by Mary WisniewskiArrow Right Banking editor
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As inflation soars to a 40-year high, consumer confidence dips to a near-record
low and the Federal Reserve looks on track to hike rates at the fastest pace in
decades, the top concern facing the U.S. economy right now is that the rug might
be ripped out from underneath it — kickstarting the next recession.

Economists in Bankrate’s Second-Quarter Economic Indicator poll put the chances
of a recession in the next 12 to 18 months at 52 percent. Yet, preparing your
wallet for any downturn requires work long before the recession officially
starts. Here are nine tips to help make sure your finances are more resilient
during a downturn.


1. TAKE A HARD LOOK AT YOUR FINANCES AND CREATE A MONTHLY BUDGET

Recessions often take away Americans’ comfort in the economy, leading to reduced
job security or worse, job loss. The bottom line is preparing for any of those
recession-induced emergencies comes long before the downturn actually starts.



If you’re feeling uneasy about the economy right now, the most important step
you can take is familiarizing yourself with your monthly budget. In an
emergency, you want your income to last as long as possible. Having an idea of
how much money is flowing out of your pocketbook — and where it’s going — can
help you identify the best course of action for planning how you’d handle
unemployment or any other emergency.

Write down every financial firm you regularly work with and whom you regularly
pay a bill to. See how much cash you have available right now, whether in a
checking or savings account. Find out the categories where you spend money most.
It’s always a good idea to go through your monthly expenses and identify which
items are discretionary — services or items you can live without — and which
items are a necessity.

Creating a monthly budget is even more important to ensure you’re living within
your means and not overspending. Doing so when the economy is strong could help
set you up for success during bad economic times.


2. LIMIT YOUR EXPENSES, PARTICULARLY BIG-TICKET ITEMS

Once you get an idea of how much money you’re spending, try to find the areas
where you can cut back. Most of the time, those are nonessential purchases.

“You have to pay your rent; you have to pay your car insurance; you have to eat
to live. Your groceries, your utilities — those are all going to be essential
expenses,” says Lauren Anastasio, CFP, director of financial advice at Stash.
“But dining out, vacations, cable — anything that you would potentially consider
a luxury or a lifestyle expense — that’s discretionary spending.”

Sometimes, it’s easier to start small. Try cutting back on meals out, reducing
the number of streaming services you have or refraining from making any major
financial commitments you don’t immediately need, such as going on vacation or
paying for a months-long membership.

Experts typically recommend spending no more than 30 percent of your net income
(that is, earnings after taxes) on discretionary items.



After that, it might make sense to reduce the bigger-ticket purchases — though
sometimes it’s easier said than done because it could involve a lifestyle
change. Some Americans might find success in moving in with roommates to limit
how much they spend on rent. Another alternative? Trim your monthly mortgage or
car payments by refinancing any loans you have.


3. PAY DOWN HIGH-INTEREST CREDIT CARD BALANCES AND REFINANCE VARIABLE RATES INTO
FIXED

The other costliest corners in your budget could be high-interest, variable-rate
debts. That’s even more true at a time when the Federal Reserve is lifting its
key interest rate — known as the federal funds rate — by the fastest pace in
decades. The Fed’s actions influence all other forms of short-term borrowing.

High-interest debt commonly comes from a credit card. Even when the Fed’s rate
was at its lowest, the average credit card annual percentage rate (APR) hovered
close to 16 percent, according to Bankrate data. Carrying a balance from month
to month could potentially cost you hundreds, if not thousands, more a month.

“Being in a position where you’ve eliminated those types of high-cost
obligations allows you to better prepare for other things financially,”
Anastasio says. “The more you’re able to put aside for saving and the less debt
you have, it’s going to be available to you in case of an emergency.”

Use Bankrate’s tools to calculate a debt-payoff plan or take advantage of
balance-transfer credit cards with zero percent intro APRs.


4. USE THE FREED-UP CASH TO BOLSTER YOUR EMERGENCY FUND

Freeing up breathing room in your budget is crucial because you can then use it
to bolster your emergency fund. A February 2022 Bankrate poll found that 22
percent of Americans have more credit card debt than savings. Meanwhile, more
than half (58 percent) of Americans in a June Bankrate poll are concerned with
the amount they have in emergency savings.

Part of the reason why an emergency fund is so crucial is because unemployment
insurance (UI) on average only replaces half of jobless Americans’ income. The
average weekly benefit in the U.S. reached $398.87 in the first quarter of 2022,
according to the Department of Labor. Not to mention, unemployment benefits
eventually expire. Most jobless Americans can expect 26 weeks of benefits, with
some states paying more and others less. Congress has the power to enhance the
program, as lawmakers did during the coronavirus pandemic — but with inflation a
top concern, an extension as generous as before might be off the table.

To help serve as crucial income, your emergency fund should cover at least six
months’ of expenses, according to financial experts. That can seem like a
daunting task, but don’t underestimate the power of small contributions.

Regularly adding to a high-yield savings account over time can build the crucial
savings habit. Better yet, automate your contributions to put the process on
autopilot.


5. DECIDE WHERE TO PARK YOUR EMERGENCY FUND

Next comes the important step of deciding where to park your cash — a task even
more important when inflation is high.

Banks are lifting savings yields at a rapid pace in response to the Fed’s
aggressive rate hikes. Right now, the highest-yielding bank in Bankrate’s list
ofBest Bank Accounts is earning about 17 times the national average.

But don’t sacrifice liquidity for yield. In a downturn, you want to make sure
your cash remains liquid and accessible, so you can turn to it whenever you need
the cash. That means you shouldn’t lock up your money in a certificate of
deposit (CD) or select an account that limits your number of withdrawals.


6. ASSESS YOUR INDIVIDUAL FINANCIAL SITUATION BEFORE PAYING OFF OTHER DEBT

U.S. households have more than just credit card debt. Americans also have $11.4
trillion total in mortgage debt, $1.6 trillion in student loan debt, $1.5
trillion worth of auto loans and $319 billion on home equity lines of credit
(HELOCs), according to the New York Fed’s survey of household debt and credit
for the second quarter of 2022.

But it might not make sense for consumers to concentrate on paying down debts
that have relatively low interest rates and attractive provisions. One such
example could be student loans, according to Greg McBride, CFA, Bankrate chief
financial analyst. Borrowers are often able to negotiate a temporary payment
plan or apply for forbearance in the event of unexpected job loss, though rules
differ for private lenders. Another case in point: Federal borrowers’ payments
have been on pause for more than two and a half years due to economic
disruptions from inflation and the coronavirus pandemic.

Take a look at your emergency fund. If you don’t have much cash that you could
use in the event of unexpected job loss, you might want to consider allocating
any extra money toward your savings account instead. A lack of savings might be
another reason why consumers keep incurring credit card debt. A January Bankrate
poll found that less than half of Americans (or 44 percent) could cover an
unplanned $1,000 expense with their savings.

“If an emergency arises and you’re putting every dollar toward eliminating debt,
you have no choice but to go back to credit cards to cover the expense,”
Anastasio says. “Everyone needs to have a cash cushion.”


7. DON’T MAKE KNEE-JERK REACTIONS WITH YOUR INVESTMENTS

A downturn is often synonymous with a plunging stock market. Companies often
find it hard to hire, expand and invest when times are tough. Even worse, they
might decide to start laying workers off.

But changing your strategy during a recession would be the worst thing you could
do, McBride says. That goes for all individuals, whether they’re 20 or just two
years away from retiring.

“It will take a tough stomach because in a recession a stock market will easily
fall 30 to 40 percent, peak to trough, but making regular contributions and
reinvesting all of the distributions will make those market gyrations work to
your benefit,” McBride says. “A recession is a tremendous buying opportunity.”

If you’re planning to retire in the next few years, consider having your first
few years of withdrawals already on hand, in cash. But even then, don’t shy away
from keeping equities in your portfolio. Those are often where you’ll get the
best returns adjusted for inflation.

“Do not make changes that jeopardize your long-term financial security based on
short-term economic events,” McBride says. “Even for someone who is on the cusp
of retirement, retirement is going to last 25 to 30 years. A recession is going
to last a year.”

Even so, the market doesn’t always behave the way you’d expect it. After
plunging nearly 31 percent in March 2020, the S&P 500 took off like a rocket
during the coronavirus pandemic, hitting 70 fresh all-time highs in 2021 alone,
despite the economy being in the worst recession since the Great Depression.

A lot of that’s because markets are forward-looking: Even when the U.S. economy
is in the middle of a recession, investors could be looking ahead by months, if
not a full year, to when the environment is better.


8. THINK ABOUT YOUR CAREER AND EARNINGS OPPORTUNITIES

To recession-proof your career, one of the best investments you can make is
pursuing an education, says Tara Sinclair, an economics professor at George
Washington University and a senior fellow at Indeed’s Hiring Lab.

During recessions, the unemployment rate for those with a bachelor’s degree or
higher is much lower than for those who have a high school education or less.
Joblessness peaked at 5 percent for those with a bachelor’s degree or higher in
the aftermath of the Great Recession of 2007-2009, compared with 11 percent for
those with no college and just a high school diploma, according to the
Department of Labor.

Networking and maintaining strong connections with workers in your field could
also help you find new opportunities before they’re listed online in what’s
bound to be a more competitive market. Better yet, strengthening your skill sets
and pursuing more training could make you more marketable in your field.

“Economists are always emphasizing the importance of education,” Sinclair says.
“Even if you can’t build up a financial buffer, focusing on making sure that you
have some training and skills that are broadly going to be employable is really
crucial.”


9. DON’T PANIC: RECESSIONS ARE INEVITABLE, BUT THEY’RE NOT ALWAYS AS BAD AS THE
CORONAVIRUS PANDEMIC OR THE GREAT RECESSION

“Recession” is a scary word for the Americans who’ve lived through two severe
recessions, each surprisingly more severe than the last: the coronavirus
pandemic and the Great Recession before it.

Even worse, attempting to predict economic downturns — the way many are
attempting to do right now, amid decades-high inflation and an aggressive Fed —
will set even the experts up for failure. No event illustrates that more than
the coronavirus crisis. At the beginning of 2020, economists hadn’t even
considered that a global outbreak could wreck the U.S. economy’s longest
expansion on record.

Though most economists would lump the two causes of recessions into supply
shocks or demand shocks, each of the past 33 recessions (as tracked by the NBER
Business Cycle Dating Committee) have been caused by something a little
different, Sinclair says.

“Some people say economists exist to make weather forecasters look good,”
Sinclair says. “The complexity of the macro economy is such that we haven’t yet
figured out a clear, causal model of how things work. We can’t predict with any
kind of confidence what’s going to happen, particularly when things are changing
dramatically. Obviously, if recessions were easily predictable and preventable,
we’d expect policymakers to be doing just that.”

The most basic definition of a recession is a sustained period of economic
contraction across the economy. Simply put, the start of a recession is the
point at which the economy is contracting, not growing.

But not all downturns crater U.S. economic growth and cause double-digit
unemployment. In the aftermath of a recession in the early 2000s, nationwide
unemployment peaked at 6.3 percent. The recession before that, joblessness rose
to a high of 7.8 percent.


BOTTOM LINE

Taking steps to prepare your wallet for a downturn when times are good can help
take away some of the stress and worry surrounding recessions. And rest assured:
Even if economists can’t predict recessions, they almost always know when the
U.S. economy is in the middle of one.

For Americans, “I don’t think there’s ever a bad time [for them] to evaluate
their finances and check in with themselves,” Anastasio says. “If someone
personally feels nervous that there’s change on the horizon, it’s always a good
time to say, ‘What can I do personally to put myself in a stronger financial
position, so I can sleep better at night when the time comes?’”


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Written by Sarah FosterArrow Right U.S. economy reporter
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Read more from Sarah
Sarah Foster covers the Federal Reserve, the U.S. economy and economic policy.
She previously worked for Bloomberg News, the Chicago Tribune and the Chicago
Daily Herald.
Edited by
Mary Wisniewski
Edited by Mary WisniewskiArrow Right Banking editor
Mary Wisniewski is a banking editor for Bankrate. She oversees editorial
coverage of savings and mobile banking articles as well as personal finance
courses.  
 * Connect with Mary Wisniewski on Twitter Twitter
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Mary Wisniewski
Banking editor


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