How to Prepare Your Finances for the Next Recession

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This is a difficult topic to take on in the current economy. At least right now, a recession seems unlikely, and some are saying impossible. But the current economic expansion – anemic that it is – is now about 10 years old. That makes it the longest expansion on record. As the saying goes, what goes up, must come down, and so it will be with this expansion. That’s why we need to discuss now how to prepare your finances for the next recession. It’s coming.

How to Prepare Your Finances for the Next Recession
How to Prepare Your Finances for the Next Recession

Preparation is so important, precisely because most people don’t see – or don’t want to see – trouble on the horizon. But if you’re prepared, you’ll be able to minimize any negative fallout.

What can you do to prepare your finances for the next recession?

Prepare Your Finances for the Next Recession – Get Liquid

Liquidity might be the most underrated concept in the personal-finance universe. Some people have six-figure incomes, six-figure investment portfolios, six-figure retirement plans, and six figures in home equity. But when it comes to liquid savings sitting in a bank account, it’s mostly moths and cobwebs.

But when a recession hits, and income, investments, and property values get shaky, the importance of liquidity suddenly becomes obvious. It should be at all times, but when everything seems to be growing in value, and credit can be had only everywhere, liquidity just doesn’t seem as important.

What’s often forgotten is the basic purpose of liquidity is to create a barrier between your immediate financial needs and your long-term assets. With no savings, you’ll be forced to liquidate investments to cover short-term financial needs. And rest assured, forced investment liquidation usually comes at the worst of times. It won’t happen when a particular stock you own has topped out at $100. No, instead it’ll happen after that same stock has fallen to $50. Once you sell it, you’ll have locked in your loss.

Another blogger once said something to the effect that “a lack of money is what causes small problems to turn in the big ones”. That’s the strongest argument for liquidity. An $800 car repair is only a problem if you don’t have cash to cover it. Then you’ll have to turn to credit, or engage in a mad scramble to find it anywhere you can.

Recessions have a way of creating unstable financial situations. You have an opportunity now to insulate yourself against most of them by building up true liquid savings. For most people, having enough in a bank account to cover living expenses for between three months and six months will cover most short-term needs.

Rearrange Your Investments to Prepare Your Finances for the Next Recession

The prevailing investment psychology today is to invest in index funds and ride the market up. After all, based on the S&P 500, the average annual rate of return on stocks has been about 10% going all the way back to 1926. Who would bet against that kind of track record?

The strategy has worked brilliantly over the past 10 years. But this is when it’s important to realize that the oft-cited 10% return is nothing more than an average. Over that 93-year time span there have been years, and even entire decades, when the market has returned something less. During certain time frames, it’s been down – a lot.

Recessions aren’t a time to bet on averages, because they usher in counter-cycles. The investment strategy that works so well during economic expansions may be a guaranteed loser in a prolonged recession.

You don’t need to liquidate all your stock holdings. But you should begin making gradual shifts, such as the following:

  • Stop or reduce new stock purchases. Instead load up on cash and fixed income investments. Not only will they protect more of your money from a downturn, but they’ll provide you with the funds you’ll need to begin buying at the bottom of the market.
  • Look for more specific investments. Move money from index investing into “dividend aristocrats”, value stocks, and certain industry sectors likely to outperform the general market in a downturn.
  • Move a small amount of money into precious metals, cryptocurrencies, and certain real estate investment trusts (REITs) that have performed very well in the last recession and since.

The idea is to move beyond basic index investing, in preparation for a very different kind of investment environment.

Lower Your Debt Level

Debt – which is so easily tolerated during expanding economies – can be a veritable Achilles’ heel during a downturn. That was certainly the case during the Financial Meltdown that began in 2007. It wasn’t so much people who had little debt that got hurt. But those with large debts got clobbered. This was most obvious with housing. People who had either made minimum down payments to buy properties at or near the top of the market, or borrowed all the equity out of their houses, were the most likely to end up in foreclosure.

Culturally, our society makes light of debt. Businesses and economists promote it as a way of generating sales and “stimulating the economy”. But on an individual basis, we should know better. In its most basic form, debt is all about paying yesterday’s expenses today, or today’s expenses tomorrow. It’s a financial imbalance, since it reduces future income. And if a recession causes future income to be uncertain, there may not be enough available to service the debts that are being run up now.

There may not be much you can do about large loans, like the mortgage on your house or large student loan debts. But you should do your best to pay down any debts you can.

The Credit Card Complication

This should certainly start with credit cards. They come with high interest rates, that makes paying them off close to impossible. There’s even a saying to describe that conundrum: Once a Visa, always a Visa. That’s not just someone being cute either. The whole concept of revolving credit is designed to get you into debt, and keep you there forever.

When banks can charge as much is 25% on a credit card, they have every incentive to make sure that happens. Your goal should be to do the exact opposite. Credit cards are the epitome of “bad credit”, and will represent a drain on future income.

But there’s another potential dilemma most don’t consider, and it’s the possibility of credit lines being frozen or reduced in a recession. It happened in the last one, and left a lot of people stuck. The bank cuts your credit line from $10,000 to $5,000; if you owe $4,800 on the card, you’re instantaneously “maxed-out”.

The Car Loan Complication

Car loans are a close second to credit cards, but in a different direction. The basic problem with a car loan is the large monthly payment. With today’s car prices, it’s not unusual for a monthly payment to be $400, $500 or more. We may have gotten used to that in recent years, but it will be difficult to manage on a reduced or eliminated income.

Complicating the car loan situation is the fact that financing represents a lien against a survival asset. A car is a survival asset because it’s required to make a living for most people. At a minimum, that involves the ability to commute to and from a job. But if you have a business, it can be even more important. In either situation, should you lose your car to repossession due to inability the service the debt, not only would your credit be crushed, but your ability to earn a living would be impaired.

If you only owe a few thousand dollars on your car, pay it off as soon as possible. And if you owe a large amount, pay down as much as you can. The idea is to get it low enough that you may be able to pay it off if you lose your job or are forced to take a major pay cut.

The Best Way to Prepare Your Finances for the Next Recession – Have a Back Up Income Source

One of the most common features about any recession is the elimination of jobs. But in the more complex employment world we’re in now, underemployment could be the bigger problem. People working full-time could find their hours cut to part-time, as employers look to cut costs.

Are you even remotely prepared for that type of outcome? You need to be. Most make the general assumption that they’ll be able to weather out any short-term income disruptions by a combination of savings and unemployment benefits. But each has limitations.

Unemployment benefits are only a fraction of your employment income. And since they cap benefits at a certain flat weekly amount, the situation is even more pronounced for higher income earners. For example, in Georgia, the maximum unemployment benefit is $330 per week. But if you currently earn $1,000 per week, that will only replace one third of your income.

Still another issue on the unemployment front is that it’s now easier for employers to block your benefits claim than ever before. They have an incentive to do this, because the higher the number of people they have collecting benefits, the higher their contribution rates into the fund will be. It’s entirely possible your unemployment claim will be denied.

You may be able to rely on savings, and you absolutely should have them prepared. But that will only work as a short-term solution. If you’re either unemployed or underemployed for a year or longer, you can completely drain your savings.

A Side Business to the Rescue

That’s why a backup income source is important. It can provide an income if you’re denied unemployment benefits, as well as minimize the draw down on your savings. And if your hours are reduced in a crunch, the second income source can fill in the gap.

I often recommend starting a side business on this website. But it can become downright critical to prepare you your finances for the next recession. Not only can it be a source of income during the time of unemployment or underemployment, but the second income can provide additional funds to build up savings and pay down debt.

Starting a side business is worth doing even if you’ve never contemplated it before.

Many people, fearful of the entire prospect of self-employment, reason they can achieve the same outcome with a second job. That idea is loaded with pitfalls, especially in a recession.

First, a second job could be lost just as easily as a first job – and even for the same reasons. Second, since second jobs pay on an hourly basis (and not very much at that) your income potential will be limited by the number of hours you can work. Working too many hours can lead to burnout, which will put an end to juggling two jobs.

Finally, there’s the fact that competition for part-time jobs tends to become heavy during economic downturns. The second job you assume to be there may not when the storm arrives.

Carefully Evaluate Major Spending Plans

If you’re preparing to buy a home, or to trade up to a higher-priced home, or by a second home or a brand-new car, this may be a good time for some serious reflection.

Historically, people tend to buy houses and cars at or near the top of an economic cycle. After several years of steady economic growth and stable income, they reason that it’s safe to make a major purchase. Unfortunately, that kind of thinking can lead to personal financial disaster.

The saying on Wall Street is “buy low, sell high”. But when you buy at the top of an economic cycle, you’re doing the exact opposite. Chances are, any house or car you purchase will be more expensive now than it will be when the economy sinks.

This is another major reason so many people ended up being “underwater” on their mortgages in the last recession. They flocked to buy overpriced houses at the top of the previous market, often with zero down payment loans, and ended up in a negative equity situation.

Be careful of adding any major obligations to your current budget. You’ll be forced to maintain those obligations at a time when circumstances may not be so favorable.

A wiser use of additional funds may be to increase savings and either reduce or pay off existing debt.

It all figures significantly in how to prepare you finances for the next recession. You should do that now while you have the time.

( Photo by CreditDebitPro )

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16 Responses to How to Prepare Your Finances for the Next Recession

  1. My portfolio is 80 percent bonds and 20 stock. Set up about a year ago. It realized 4.1 percent return. Stocks have been treading water for the past year. Glancing at market graph for the past 50 years revealed 20 year stagnant market in the seventies/eighties. In 1982 a CD was yielding 14 percent.

    In light of the very real scenario the market could stagnate for an extended time period, 10 years according the information below, I will instruct my advisor to liquidate stocks if and when the market reaches an appropriate bail-out point. Unsure what the best approach involving liquidity is at this point.

    Two insightful articles.

    A 2019 Bear Market and Subsequent Lost Decade in Stocks Lurks on the Horizon

    Barry Bannister, Stifel’s prophet of doom

  2. I have similar observations and opinions George. The market has been running in place since January 2018, but every time it rallies back from a fall, everyone cheer’s the bull market is alive and kicking. I’ve read several analysis that predict a prolonged flat market, maybe a decade or more. And I can see that, more so than a crash. It’s going to make it hard to play this market.

  3. You have basically described how I have conducted my financial life for the past 35 years. I have never had debt. Not even a mortgage.

    Sure I might not have made the money I could have by being more aggressive but I have never lacked and I never noticed the last downturn in 08.

    No Debt, Savings and smart growth are time-honored ways a healthy financial life. They have never changed. They worked 200 years ago and they still work today.
    This is the way 90 percent of the population should live all the time. Not just trying to do this before a recession that can never be timed anyway.

  4. Hi Tim – Your financial prescription is right on the money for the middle class. Unfortunately, credit has enabled the middle class to pretend to be rich. That’s what gets people in trouble. Getting deeper in debt right now might prove to be especially problematic. There’s to much debt right now, and if employment gets week, we’re going to see defaults in more than housing. I agree that the more liquid you are (high savings, low debt) the more likely you are to come out of a recession unscathed. But that doesn’t seem to be the American way, and hasn’t for decades.

    It’s weird. Back in the 70s and 80s there were recessions, but people weathered them. They may have given up vacations, new cars and dinners out, but very few people ended in in bankruptcy or losing their houses. It goes to show how far we’ve fallen on financial security. I guess back in the 70s and 80s people still had some “religion” from the Great Depression. Not any more.

  5. True, I never heard my father talk about a recession. They did happen but it never seemed to matter to him.

    He never really had a portfolio. I never heard him talk about stocks. I don’t think he had any. It isn’t like today where everybody and their brother think they are a stock broker. He had silver, gold and savings and a paid for house and car. He always lived like armageddon was right around the corner. No matter what was happening.

    I’ll admit that I haven’t a clue what George said above. I have patterned myself after what I was taught. It worked for him and it has worked for me.

    Like I said, my goal in life was never to be rich. I never really cared. I have made way more than I ever thought I would. I have clothes, food and a roof over my head. I have a retirement account. I can whether storms if need be. That is really all that matters.
    I just keep doing the same things I have always done. Just building upon the starting point I had many years ago.

    How many homes or cars can you buy anyway? I would rather travel and go to some nice concerts or restaurants than live in a mansion.

  6. I know it sounds boring. I learned early on when my father passed when I was 14. My mother never had to get a job. She finished raising my sister and I without much change in our life. They were prepared. It taught me the value of always being prepared for the unexpected.
    We could wake up tomorrow in a global financial meltdown. You never know what life will throw at us.

  7. HI Kevin:

    I think many people have gotten caught up in the 401 / retirement craze and have forgotten about the importance of having some cash which is easily accessible. I don’t mean to call it a craze, I just couldn’t think of a better word at the moment. Retirement funds are very important and necessary, and a 401 is often all most people have from their employer. But in today’s economy, sadly, I believe it takes more than that. As you said, keeping some money in an interest earning savings account or CD, having little to no debt, and some other assets that you can get to in an emergency. Those close to retirement should be checking their accounts for risk tolerance and assessing their personal situations. Watching the markets these days is stomach-churning, so I think it’s always prudent to keep a very healthy savings account in case it’s needed. Prudent money management in good times and in bad.

  8. I agree Bev, and as you know from previous articles I’ve written, I think a lot of people have become obsessed with retirement. I think they lose sight of the present or the near term when they hyper-focus on retirement. Statistically what you’ve said is true. A lot of people have a 401(k) and nothing more. That will leave them poorly prepared for a serious downturn. I remember in the last two stock market crash hearing a lot of people complaining about losing a bunch of money in their plans. It’s really sad they’re constantly being told that a 401(k) is all they need, because that’s only one part of the personal finance equation, and a very limited one at that. There’s a whole bunch that happens between now and retirement that everyone needs to be prepared for. And even if you are retired, a 401(k) doesn’t protect you against every crisis. It’s a good plan to have but it hardly covers all contingencies. We’ve lost the value of cash in the bank, and other savings/investments for the near term. But then a lot of people are profiting off the retirement mania, so none of this is surprising.

  9. I’m not sure if people count insurance as part of a life plan.
    I think a good mix would be cash a 401K or whatever you have and proper insurance.
    A good balance between the three is good.

    Just from experience my parents had an insurance policy that paid off there house if my Father should pass before it was paid off.
    He actually had a mortgage which was something I was dead set against. We’re not much different with money but that was one of the differences between us.

    While it just so happened that he passed before they we’re done paying off the house. The policy paid it off. Granted he only owed maybe 15,000 on the house.
    That was the only reason my mother was able to continue on living there with us.

    They had savings and good insurance. They were prepared. He never made it to retirement. If he would have focused only on that we would have been far worse off. He hadn’t had enough in his plan to make any bit of difference and with penalties and taxes it would not have come to much if it needed to be liquidated.

    I’m not saying not to put away some for retirement but your right. There is too much obsession with focusing on one thing at the loss of other things that are important part of the plan.

  10. I think a lot of people, maybe most, underestimate the importance of life insurance. It’s REALLY important if you have large debts or young kids. Any savings you have will eventually be exhausted and that’s where insurance can help. Ironically, it’s more important for people of limited means to have life insurance precisely because they don’t have a lot of capital. For the well-to-do, who have hundreds of thousands or millions in savings and investments it’s less important.

    I agree, savings plus retirement plus life insurance. And as little debt as possible. That mix will help you both in life and for your heirs after you’re gone.

  11. Actually, Tim, I think life insurance is a very good suggestion. I hadn’t thought of it. It’s not going to help you in a recession, but it is part of a good life plan, as you said. This is true especially for households who rely only on one income, i.e., stay-at-home mothers, etc. If something should happen to the breadwinner (I dislike that term immensely)…then the family is left struggling to get by. I saw this happen to my sister who was a stay at home mom for years. My brother-in-law worked but ended up with back surgery and then disability. He died shortly after and she was left with nothing. They were not prepared, and a good life insurance policy could have helped them, which they didn’t have…God knows why! Anyway, good suggestion. I know we’re talking about finances and a recession in this post, but it still may give others something to think about for the future.

  12. Here is the problem though for most people.

    I’m a basic salary here, which is probably the average. Let’s say you make 60,000 per year. So in reality you bring home about 51,000 cash after a 15 percent tax bracket
    If you invest 20 percent of that in cash savings, 401K and an insurance policy that’s roughly 10,200 per year.
    That leaves you 40,800 for the rest of the year. That leaves you 3,400 per month or 850 per week for a mortgage, car payment & insurance, food utilities and whatever pops up in your life. Which it is always something. The average mortgage is 1300 per month? I’m not sure. Car payment is 300 per month. Probably more if you have two cars. It probably leaves you about 450 per week. One food shop for a family of four is 200.00.

    It doesn’t leave you much.

    This is why people are unfunded for retirement or have no life insurance or savings to fall back on. If you split between the three it does not amount to much per year. 2040 per investment.
    The numbers do not work in real life for many many people.

    That is why I constantly harp on having zero debt. It can be done but too many people live above there means because they have no basic clue of how to deal with money or do the math.

    The plan is not that hard but too many people do not know how to deal with this.

    It is part of a life plan or should be but the numbers don’t really work.

  13. Correction
    3400 per year between the three. It still won’t amount to much. At this rate one of the three has to go.
    It’s usually life insurance.

  14. Tim you just explained why so many people have so little in savings, investments and insurance. There just isn’t much left over after paying for basics. The only alternative is to live well below your means for long enough to build a nest egg. But that’s also hard to do in a consumer driven economy.

  15. I know. It’s basic common sense. You don’t need financial degrees or a planner to figure this out.

    Sane thing I said about the original post. If you live in a recession mindset all the time most people would be better off.

    Once a real one hits it shouldn’t matter because your already in that mode anyway.

  16. Flat stock market comment – look at Japan for the last 30 years – still trying to hit a new all-time high, but nowhere near it

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