On paper, a recession is a fall in GDP for two consecutive quarters. Unfortunately, the actual GDP report lags the quarter-end by at least a month and is constantly revised as new data is evaluated, making it hard to confirm a recession before the fact.
However, that doesn’t mean there aren’t telltale signs. During a recession, markets tend to pull back, and the stock market may even fall into a bear market (when stock prices fall 20% or more from recent highs). Businesses may cut hours, lay off employees or freeze hiring to stay afloat. Also, as consumer demand decreases, companies tend to have a hard time selling their inventory. So products that were once in demand and “out of stock” may become available.
Here are five ways you can prepare for a recession:
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1. Make sure your financial plan is up to date
You don’t want to be left flustered if conditions begin to deteriorate because you haven’t planned for it in advance.
Questions to ask when reviewing your investments:
- What are you investing for? A short-term goal like a house down payment, or something long-term like retirement?
- How long were you planning to invest? A year or two, or is your time horizon longer?
- What are you invested in? Are you over-concentrated in a few positions, or properly diversified?
- What will you do if the stock market drops 10%, 20% or 30%? Buy, sell, or hold?
- Will you need any of the money invested in the near term? How insulated from market volatility does your investment need to be?
2. Review your budget
Ask yourself, “How much money do I need to earn to pay my bills and cover my essential spending?” This is your basic income required, and you should ensure you can continue to produce this amount.
If you are married, plan for what your budget would look like if one of you loses your job. If your finances are looking tight, search for areas to cut back spending, bills that can be eliminated or loans refinanced.
3. Fully fund your emergency savings
As a rule of thumb, you should have three months' worth of bills or $3,000 saved for an emergency, whichever is greater. A recession is a good time to get more aggressive and save for six months’ worth of bills or $6,000, whichever is greater. Ensure emergency funds are easily accessible and not invested to avoid the potential of loss from market volatility.
4. Pay down debt
Stay on top of your debt by paying off any credit cards and high-interest rate products now when income is flowing and economic conditions are generally still favorable. You should also focus on improving your credit score in case you need to borrow in an emergency.
5. Network and earn additional income
Building your professional network may increase your chances of getting a job, which could be helpful in the rare case you are laid off during a recession or need additional income. You can also look for side gigs or think about a business you want to build now as a way to earn passive income in the future, diversifying your revenue streams.
Although the thought of a recession can be scary, it’s a normal economic event. One that we’ve experienced in 2020, 2009 and 2001 in this century alone. Training yourself to pick up on the telltale signs, along with thorough preparation, is the best way to protect yourself and stay ahead of the curve.
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