Economies are cyclical. That means they go through periods of expansion and growth, as well as periods of decline known as recessions. Or more severely, depressions.
During a recession, there is typically a decline in industrial and trade activity. This can severely impact your personal finances! So you'll need to have a plan in place for how to prepare for a recession. Some major implications that come with recessions include job losses and unemployment, a drop in real estate values and the decline of investment values.
"Whether there is a recession going on or not, life goes on and bills need to be paid. So you need a solid plan in place to get through a difficult economy."
However, regardless of whether there's a recession going on or not, life goes on and bills need to be paid. Are you wondering how to prepare for a recession? This blog post will show you the 5 important things you need to be doing now so a recession doesn't become a personal financial crisis for you.
How to prepare for a recession
1. Bulk up your emergency savings
It's very important to have emergency savings in place. In a recession, having a fully funded emergency fund can save you a lot of stress and help you avoid becoming financially over-extended or having to leverage debt just to get by.
To start, you want to put aside 3 to 6 months of your basic living expenses in an emergency account in the unfortunate event that you become unemployed. And since recessions can be pretty unpredictable, aim to boost your emergency savings to 12 months of your basic living expenses. This will give you ample time to find a new job. But remember, jobs can be harder to come by in an economy experiencing a recession.
2. Diversify your investments
Ever heard the saying, don't put all your eggs in one basket? Well, the same line of thinking applies to your investments. It's important to have a well-diversified investment portfolio. That means your investments should not all be tied up in one stock or in one real estate property.
Make sure your investments are spread across multiple industries and areas so if one industry or area experiences a decline, it doesn't sink your entire portfolio. For example, if you are invested in the stock market, you can spread your investments across multiple sectors such as consumer goods, healthcare, technology, etc. Mutual funds and index funds are both great ways to diversify. You can also choose to invest in the stock market (funds and bonds), the real estate market, and in small business.
Whatever you invest in, be sure to do your research, be clear on your investment objectives (your risk tolerance and when you'll need your money), and don't panic if a recession comes along. Don't start selling every investment you own when the economy dips; it's a bad idea.
If you have a clear plan for your investments—you're adjusting based on your objectives and you're in it for the long term—your investment is likely to weather a bad economy and come out on top. Talk to a financial advisor if you are confused or feeling stuck regarding what to do.
3. Pay off debt
The last thing you want to do is worry about having to pay off debt in a bad economy, especially with the increased rates of unemployment. Paying off your debt save you a ton of money in interest payments. And you'll also be able to put your extra funds toward bulking up your emergency savings and other financial goals.
Focus on paying off your high-interest debt before you consider investing. This will save you some money. For example, if you have a credit card that has a 19% interest rate, then it makes more sense to pay off that debt unless you know for certain your investments are going to give you a return greater than 19%. Even that is speculation at best because it's very hard to predict or time the outcome of investments.
Once your debt is gone, you can focus on investing as much as you want. Learn more about creating a smart debt repayment plan.
4. Learn how to budget and live within your means
Living within your means is the key to building wealth. It also means you eliminate having to leverage debt in order to live your life—no more using credit cards to pay your bills. Wondering how to prepare for a recession and live within your means? Learn how to budget. Your budget will help you track your expenses in comparison to what you earn and will highlight areas you can cut back on.
Your ultimate goal should be to widen the gap between your income and expenses as much as you can (by increasing your income and reducing your expenses). The money you have left over is money you can use toward the things that really matter to you, like your savings and investment goals.
Here's how to determine what budgeting style works best for you.
5. Create multiple means of income
The average millionaire has 7 sources of income, and for good reason! Creating multiple streams of income ensures that you increase how much you have coming in. And it also acts as a buffer in case you lose a source of income.
Is there something you're passionate about doing? Something you do that you get complimented on all the time? Consider turning it into a side hustle to generate some additional income. Here are some tips!
You can't predict when a recession will happen. So if you're wondering how to prepare for a recession, these tips should get you started. It's important to keep in mind that regardless of what's happening in your country's economy, you can experience a personal recession too. So it's best to be prepared. What are you doing to prepare yourself for a recession?