No one can predict the year and quarter that a recession will hit, but, thanks to a few common economic indicators, it’s not difficult to see when one might be around the corner. America is currently in the second-longest economic expansion in its history, per Nasdaq, and the last recession (“The Great Recession”) started in 2008, so it’s been 10 years of straight growth. While economists disagree as to exactly when the next recession will hit and how bad it will be, most agree that we’re overdue.
You don’t need to be paranoid and start saving your money under a mattress, but now is a good time to learn what a recession is, how to prepare your personal finances to avoid a life-changing hit and how to ride one out. Hey, it’s always better to be safe than sorry.
A recession is loosely defined as two consecutive quarters of economic slowdown, such as two back-to-back quarters of negative Gross Domestic Product (GDP) growth. Other factors that indicate we’re in a recession include a rise in unemployment, a decrease in wages, a drop in consumer and business spending and a decrease in manufacturing.
During a recession, you’ll see a variety of positive and negative results regarding your personal financial situation. A recession usually results in more layoffs, possible a salary decrease and less job security for you. That’s because your company has less money to hire and retain employees, and other people are willing to do your job for less. In addition to job insecurity, you might be blindsided and lose your job, resulting in lost wages and benefits, such as healthcare and retirement contributions. Even if you keep your job, you might lose some, or all, of your benefits, have your hours cut back or be asked to take a pay cut.
During a recession, credit might tighten, too, as many commercial and consumer borrowers begin to default on loans and financial institutions have less money to lend. That can make it more difficult to qualify for a credit card, get a mortgage or secure a vehicle or business loan.
Home values usually decrease during a recession. If you’re planning on buying a home, lower housing values is a good thing because you’ll be able to buy more house for less money. If you own a home and don’t plan on selling, a decrease in value means your property taxes will probably go down. If home prices go down, it will be harder to sell your house. When the amount of your mortgage exceeds your home value, you’re considered “underwater,” which can hurt your ability to sell your home or get a loan against part of it.
During a recession, the U.S. Federal Reserve is likely to lower interest rates to keep inflation in check. That’s good for you if you’re able to get credit products or have a variable rate loan or credit card.
Keep an eye on the monthly jobs report, quarterly GDP numbers and monthly housing numbers. Tracking the monthly change in the stock market is a helpful way to understand when a recession may be coming. Also, follow the Fed to see if it’s raising or lowering interest rates or keeping them the same. If it’s raising rates, its members think the economy is growing. If it stays pat, it doesn’t mean a downturn is coming, but it doesn’t signal a booming economy.
Lastly, a new wild card in the picture that might hurt the economy is the recent imposition of trade tariffs. This could spark a trade war that might damage large parts of the economy, or the sector in which you work. Ask your employer if your company will be affected by any proposed tariffs and how that might play out.
The first thing you should do to protect yourself from the effects of a recession is to meet with a Certified Financial Planner (CFP). If you don’t have a long-term financial plan in place, a CFP will help you create one. Once you’re done creating a long-term plan — which includes a monthly spending budget, debt-management program, retirement strategy, insurance needs and housing plan — create a second plan to deal with a recession. This might include getting out stocks when the market hits a certain point, staying in, but changing your investment strategy, reducing your spending or selling assets.
Whether or not you have credit card balances, a student loan or other debt, it’s always a good idea to make sure you credit is in the best shape it can be. This will help you qualify for more credit products and lower interest rates.
If you lose your job or your income decreases, you might need to use credit to keep your head above water for several months; or longer. Knowing how to investigate, manage and improve your credit is a critical skill.
Almost ready to buy a new house or take out a loan to start a new business? What happens if a recession hits shortly after you purchase a home or take out a business loan and begin building out your business? Now is the time to re-evaluate your spending, especially big-ticket items like a new home, new vehicle, vacation or other purchase, not as a recession hits the economy.
Run your numbers to see what would happen if you were out of work for three, six or nine months. Would you have enough cash to keep your home and not dip into your retirement savings? Using your retirement savings isn’t as simple as borrowing from those accounts. Since many retirement products are tax-advantaged, you might have to pay sizeable tax penalties if you don’t put the money back within 30 days of borrowing it.
Make sure you have enough savings to pay your bills for six months in the event of a job loss. If you think you can live off credit cards for many months, take into account that you will pile up debt and higher interest payments that will take years to pay off.
During the Great Recession, after dropping significantly, many people cashed out their stocks, creating a permanent loss of net worth. If these consumers had kept their stocks, many people would have seen them rebound and would have actually made more money — although they would have had to wait years for the rebound.
Along those same lines, make sure you know when to sell, when to sit tight and when to take advantage of low-priced stocks. You might think that a safe, guaranteed certificate of deposit or interest-bearing checking account is better than a loss in the market. What about paying down a credit card balance that’s at a 20 percent annual interest rate instead? Don’t try to manage your investments yourself—work with an investment professional.
Another way to prepare for a recession is to improve your job security. That means making yourself more valuable at your current company and more desirable to a new employer. If you’ve been thinking of getting certified, do it now. Take a college course that has specific work-related benefits. Ask for more responsibility at work to make sure you’re more valuable than other employees, and always manage your relationships with superiors and co-workers.
In dire cases during a recession, you might need to offer to take an unexpected pay cut just to save your job, or even agree to work for benefits only. Calculate your savings numbers to know when that offer might have to occur. Your number crunching might determine that you can take a 40 percent pay cut and still pay your bills. Remember, this also means altering your expenses, eliminating some play money for things like dining out or taking a vacation — but at least you won’t have to dip into your savings or sell your home.
In many cases, you can ride out a recession if you have a specific plan in place beforehand, so don’t wait until things start getting shaky to create a plan. This way, the only investment you’ll need to make in a recession-proofing plan is your time.
All images via Getty
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