Economies are cyclical and that means they go through periods of expansion and economic growth, which can go on for several years, and periods of decline also known as recessions or in more severe situations, depressions (extended recessions).
During a recession, there is typically a decline in industrial and trade activity and this can severely impact your personal finances. Some major implications that come with recessions include job losses and unemployment, 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 and so you need a solid plan in place to get through a difficult economy."
However, regardless of whether there is a recession going on or not, life goes on and bills need to be paid. So how do you properly prepare your finances to weather an inevitable recession? This blog post will show you the 5 important things you need to be doing now so a recession does not become a personal financial crisis for you.
5 things you should be doing now to prepare your finances to weather a recession
1. Bulk up your emergency savings
You've probably heard this talked about often and that's because it's very important to have emergency savings in place. In a recession, having a fully funded emergency account can save you a lot of stress and help you avoid becoming financially over-extended or having to leverage debt just to get by.
Ideally, 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. Given the unpredictability of how long a recession can last, getting your emergency savings up to 12 months of your basic living expenses is a great idea. This will give you ample time to find a new job since 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 thought applies to your investments. It's important to have a well-diversified investment portfolio and that means your investments should not all be tied up in one stock or in one real estate property.
You want to make sure your investments are spread across multiple industries and areas so that if one industry or area experiences a decline, it doesn't completely 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, index funds, ETFs etc are a great way to diversify). You can also have a combination of investments in the stock market (funds and bonds), in 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), don't panic if a recession comes along (don't start selling every investment you own - bad idea) along and think long term.
If you have a clear plan for your investments that you adjust accordingly based on your objectives and are in it for the long term, your investment is very 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. Not only will paying off your debt save you a ton of money in interest payments, you'll also be able to put your extra funds once your debt is paid off towards bulking up your emergency savings and towards your other financial goals.
Focus on paying off your high-interest debt before you consider investing and save yourself 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% and that in itself is speculation 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. The way to master living 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) because the money you have left over (in the gap) is money you can use towards the things that really matter to you as well as towards 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 not only ensures that you increase how much you have coming in, it also acts as a buffer in case you lose a source of income i.e. a job loss.
If there's something you are passionate about doing or something you do that you get complimented on all the time, consider turning it into a side hustle to generate some additional income.
You can't predict when a recession will happen and also it's important to keep in mind that, you can experience a financial downturn in your personal economy at any time, regardless of what's happening in your country's economy or in the global economy so it's important that you prepare yourself financially to weather any storms or unplanned circumstances that might come your way.