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Economic recession often correlates with weaker job security, lower investment returns, and diminished consumer purchasing power. As a result, it can have significant implications for your personal finances.
Fortunately, you can insulate yourself from the worst effects and turn this period into an opportunity with the right preparation. If you’re concerned about current economic trends, here’s what you need to know to prepare for a recession in 2023.
Are We in a Recession?
Generally, an economic recession is a decline in economic activity for an extended period. Textbooks typically define it as two consecutive quarters of negative economic growth, measured by the national gross domestic product (GDP).
By that definition, we’ve been in a recession since the summer of 2022. GDP growth was negative 1.6% in the first quarter of the year and negative .6% in the second, based on the most recent economic research from the Bureau of Economic Analysis.
However, there’s still significant debate regarding the possible recession since some conditions are noticeably different than during previous downturns.
For example, the latest data from the National Bureau of Labor Statistics reported a low unemployment rate of just 3.7%. For context, it peaked at roughly 10% during the Great Recession and a whopping 24.9% at the peak of the Great Depression.
However, other warning signs seem to indicate more economic trouble on the horizon. For example, inflation skyrocketed this year, reaching 7.5% year-over-year by January 2022 and (hopefully) peaking at 9.1% in June.
Source: Data from the US Bureau of Labor Statistics via TradingEconomics.com
Also, the Federal Reserve Bank Chairman stated at a July 2022 press conference that they expected a “softening in labor market conditions.” In other words, more people are going to lose their jobs.
While there’s ultimately no way to know what the future will bring, it’d be wise to take steps to protect yourself from the current economic risks. As the old saying goes, it’s better to be safe than sorry.
How To Prepare for This Recession
Recessions are an inevitable stage of the economic cycle. Since avoiding them isn’t on the table, you just need to weather them as gracefully as possible. Here are some of the best ways to protect your finances.
Make Yourself Indispensable
Recessions have many scary implications for consumers, but mass layoffs are perhaps the most significant. An extended period of reduced income and no health insurance due to job loss can be dangerous for those with thin financial margins.
Unfortunately, the percentage of people living paycheck to paycheck is higher than ever, including 78% of those earning less than $50,000 annually. Even a brief period of unemployment could send their households into a downward financial spiral.
Though easier said than done, especially on a short time horizon, making yourself more valuable at work can reduce the likelihood of losing your job if your company needs to tighten its belt.
As a result, it’s a good idea to look for ways to go above and beyond at work during recessions. For example, that could mean becoming the only one of your peers with expertise in an essential function.
Start a New Source of Income
While you can often improve your job security by making yourself more valuable to your company, you’ll never have the final say over your employment status. As a result, having a second income stream that you do control can be invaluable in recessions.
If you experience sudden job loss, you can put more time into the extra source of income and hopefully continue to pay your bills without relying on savings or unemployment insurance.
Even if you keep your job, a second income stream can give you some additional cash flow, which can be highly beneficial during a recession. For example, it can help you stave off the effects of high inflation or purchase more assets while they’re at a discount.
Fortunately, starting a small business or side hustle has never been more attainable. There are countless opportunities to make extra income through rideshare and delivery apps, freelance marketplaces, and platforms like Airbnb.
While you might prefer to look for a highly scalable or enjoyable hustle during less volatile times, you may be better off prioritizing reliable and low-risk options during a recession.
It’s definitely worth taking steps to preserve and diversify your income streams during economic downturns. However, even the best-laid plans go awry, and there’s always a chance that you’ll have to go without a paycheck for a while.
Therefore, you must save a healthy emergency fund when your earning power is high so you can pay your bills if your income decreases or disappears.
Aim to have at least six months of living expenses since that’s about the limit of how long it takes to find new employment after losing a job. If you’re more conservative, then you can hold as much as a year of expenses in emergency savings.
However, holding too much in cash can cost you in an inflationary environment. Even online savings accounts generate negligible returns right now, so keep as much money as you need to sleep soundly at night, but no more.
Also Read: The Best Net Worth Trackers in 2022
Pay Down and Avoid Debt
Debt can be a powerful tool for increasing your purchasing power, and calculating how much you can afford to borrow is relatively straightforward when your income is reliable and your job secure.
However, the risk of layoffs can make even relatively low debt payments financially burdensome. As a result, it may be a good idea to pay off your debts when entering a recession.
If you have outstanding credit card debt, it’s a good idea to start with that. It’ll probably have a higher interest rate than your other accounts. Alternatively, you can prioritize paying off installment loans since they usually have higher fixed payments.
Of course, it’s just as important to avoid taking on additional debts. Look for ways to reduce your day-to-day spending and consider postponing significant purchases.
Factor Economic Conditions into Investment Plans
Generally, when you make enough money to save each month, some of your net income should go to investments like stocks and real estate.
However, you may need to reconsider where your excess cash goes during an economic downturn. Not only is it more important to build an emergency fund and pay off your debts, but investing also becomes more complicated.
For example, we’re currently in a bear market, which means stock prices are falling. The S&P 500, a popular market index, has dropped 25% since the beginning of 2022 at the time of writing.
You may feel tempted to panic-sell, and that’s generally a bad idea. However, you may want to consider avoiding putting more money into the stock market while it’s still falling.
(Garit feels strongly that there are better alternative asset classes you can put money into, such as artwork. We’ll also dive into I-Bonds below.)
Meanwhile, real estate prices have also started to fall in many parts of the country. In 11 markets across the country, housing prices have already fallen 5% since their peak in May.
Economists at Moody’s say they expect real estate prices will go down by 15-20% across many markets if the country goes further into recession.
With rising interest rates making homes even less affordable, our analysts believe it’s probably not a good time to buy.
If you’re unsure how to factor current economic conditions into your plans, consider consulting a financial advisor for investment advice. Make sure to prepare a personal income statement and personal balance sheet beforehand.
The United States is experiencing a higher inflation rate than it has since the early 1980s. Whatever cash you hold is losing its purchasing power alarmingly fast.
To protect your money from the effects of inflation, consider buying I-bonds. They’re a form of government-issued bonds that guarantee returns equal to the national inflation rate, updated semi-annually. Through October 2022, their yield is 9.62%.
Since the stock market only grows about 10.09% per year on average, that’s an incredibly high rate of return for an investment with virtually zero risk.
You can get up to $10,000 per person (or business) in I-bonds per calendar year, but you must hold it for at least one year before you cash it. In addition, you’ll lose three months of interest if you cash it in before five years.
See This as an Opportunity
Rising unemployment, surging inflation, and falling stock prices can make recessions anxiety-inducing. However, doing your research, bolstering your financial position, and bracing yourself for tough times can help you turn this period into an opportunity.
Instead of letting fear of a potential recession paralyze you, focus on the things you can control. Use the challenge as motivation to improve yourself by taking your finances to the next level.
Find ways to increase your earning power, build an emergency fund, and pay off high-interest debt. Not only will these things help you survive the recession, but they’ll also benefit you for many years to come.
To continue learning about financial literacy, see the following articles in the series:
- Good Debt vs. Bad Debt: Know The Difference
- How To Create A Personal Balance Sheet
- Is It Better to Put a Large Down Payment on a House
- Dave Ramsey vs. Robert Kiyosaki: Who Should You Listen To?
Nick Gallo is a Certified Public Accountant and content marketer for the financial industry. He has been an auditor of international companies and a tax strategist for real estate investors. He now writes articles on personal and corporate finance, accounting and tax matters, and entrepreneurship.