5 simple ways to prepare your personal finances for a recession
Last fall, recession fears were running high. It was hard to escape the conversation; predictions for the next big crash flew all over the media while clients, friends, acquaintances, and others constantly asked the team at my financial planing firm if a recession was really about to happen.
Our answer to that question never changed, and probably won’t: We don’t know.
How to Predict Recessions: Don’t
We understand the economic downturns are normal — and expected — parts of market cycles. Because we’ve experienced over a decade of market growth, we expect a recession to happen… eventually.
The things we don’t know are when, how long, and how severe.
Even professional economists are notoriously bad at predicting precisely when recessions will happen, which is why we usually caution people to avoid market timing and trying to out-guess everyone else.
It tends to be a loser’s game.
That doesn’t mean just sit around and wait for something bad to happen — but it does mean stay cool, calm, and collected when markets do take a tumble.
Having a specific plan to follow makes this easier to do.
The Best Way to Prepare Your Portfolio: Set Your Strategy and Stick to It
Develop your investment strategy before volatility strikes; make your decisions unemotional, level-headed moments when you have time to make and research optimal choices.
When things do get stressful or trigger your fear, you’ll have your set strategy to guide you and stay on track during times when your emotions and rash behaviors could lead you astray.
Still, there’s no avoiding the fact that this is really hard to follow through on, and to do in the moment (and in the face of intense fear about the status of your nest egg).
If You Must Act, Focus on Your Personal Finances
When you’re concerned about something like a recession and it feels inevitable that it will happen (and you’re scared it will happen sooner rather than later), “stick to the plan and do nothing” is not a very satisfying answer.
As humans, we have a very strong pull to action. Our compulsion to do something, even when doing nothing is actually the best answer, is hard to overcome.
This is called action bias, and it helps explain why even though we should all know better, average investors never stop buying high and selling low.
Our instinct to react can hurt investment portfolios more than a recession itself. That’s tricky to overcome — it’s instinct, after all.
So instead of fighting against the urge to act, you can simply redirect that energy to more productive places. Stop tinkering with your portfolio, and start focusing on your personal finances instead.
That means your spending, your expenses, your budget, your goals, and your savings.
Putting your energy into managing these things will do far more to prepare you for a recession than making emotional, irrational moves with you investment portfolio ever will.
Take Control of Your Cash Flow
Your ability to spend money is largely controlled by the amount of money you earn. This is why recessions scare a lot of people: you might expect job losses or pay cuts, which impacts how much money you have to use and spend.
A very simple solution to this problem? Use less money.
Obviously, no one chooses to earn fewer dollars and how much you spend every month isn’t entirely up to you; we all have living expenses and financial obligations to meet.
But if you can reduce your expenses and cut unnecessary costs, then temporarily earning less income does not have to be catastrophic or push you into hard-to-repay debt.
Taking control of your cash flow is the easiest step to take if you’re concerned about a recession. That means:
- Eliminating expenses or purchases that are not necessary and that don’t bring you much value.
- Looking for cheaper or even free alternatives to luxury items that you buy now, and making it a habit to choose lower-cost options when you can.
- Practicing some discipline to say no to things you may want right now, so you can say yes to things you may desire even more in the future (like freedom from worry over market movements, because you know you have enough savings to get you through an emergency or temporary hard times).
Build Up Your Emergency Savings
Once you take control of your cash flow and find ways to strategically reduce your spending, put that freed-up money to work.
Take what you might have previously spent and direct it to your savings instead. If you’re most motivated by feeling prepared for a recession, then adding cash to your emergency savings might be the smart way to go.
Keep your cash reserves in a liquid savings account where none of your principal is at risk and you can easily, quickly access the money in a true emergency.
Look for high-yield savings accounts with a competitive interest rate so you at least earn a little something.
If your long-term financial security feels more important, then you might want to direct available cash to investments — and if you’re afraid of what the market could do in the short-term, putting that money into a conservative portfolio might be a smart way to weather the storm of a recession while still getting your money to work for you.
Create A Worst-Case Scenario Budget
There’s no reason to dramatically deprive yourself right now for no reason if your income is stable, you’re not spending more than you make, and you’re setting aside enough money to build up your savings.
You don’t need to force yourself into an ultra-frugal lifestyle (unless doing so genuinely makes you happy) to prepare for a recession — but you could build out a mock “worst-case scenario” budget to help you plan.
Just like you need to set your investment strategy before you’re in the middle of a challenging situation and need to make a decision when you’re emotionally charged, you can build a very lean budget to visualize what you would do if you actually had to drastically reduce your expenses to make ends meet.
This allows you to think through your options, consider alternatives, and get clear on what needs to done should you face something like a job loss or pay cut that makes it hard to pay for your current lifestyle.
Understanding your worst-case scenario budget ahead of time can also make it easier to actually implement in a crisis. You know exactly what to do and how to cope, because you already created your spending plan for the situation.
Make Yourself Marketable Right Now
Finally, instead of obsessing over your investment portfolio and wondering if you should fiddle with it because you’re scared of a recession… try tweaking your resume instead.
Now is the time to shore up your skills, make sure your resume is completely up-to-date and fully reflects your experience and accomplishments, and look at what you could do to make yourself more attractive to your current company or a prospective employer.
Should you face something like a layoff due to an economic downturn, you’ll be much better prepared to dust yourself off and hit the job market ready and capable of finding a new position (even when things get more competitive).
And that’s if you have to deal with a job loss at all; proving that you’re a key team member now can make it more likely that your company will do what it can to retain you even when times get tough.
Focus on What You Can Control
Most people feel uneasy about the potential of a recession, and that’s understandable. Like we already established: we know that recessions are normal parts of market cycles and it shouldn’t surprise you if it happens. The only thing we won’t know is precisely when the next recession will start.
But if you know how to prepare and how to keep your cool when things stop looking so rosy and people start feeling some panic, you’ll be much better positioned to ride out the storm and come out in good shape on the other side.