4 ways to protect your finances from an economic downturn – Forbes Advisor

4 ways to protect your finances from an economic downturn – Forbes Advisor

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The recent spike in oil and gas prices, continued record inflation and the first in a potential series of interest rate hikes have some pundits wondering if a recession is looming. horizon.

Although the Covid-19 recession from February to April 2020 was significantly shorter than the average recession (the average is 11 months according to a January 2022 report from the Congressional Research Service), there have been long-term financial effects for many Americans.

Some households have been able to ride out the pandemic thanks to job security and stimulus payments. Others may still be rebuilding their finances in a post-vaccine landscape.

Whichever camp you’re on, if you’ve been through the Great Recession or one of its predecessors, even the faintest rumors of a recession can make you nervous about your financial health.

You can’t predict the future, but you can take steps to strengthen your finances so you’re ready for a downturn.

Is a recession really likely?

The US economy goes through cyclical patterns, with inevitable good times and bad times.

But the growth of the economy (usually measured by gross domestic product, or GDP) and the strength of the labor market are two major indicators that our economy is in good shape and that a recession is not imminent.

Raising rates to curb inflation, as the Federal Reserve plans to do several times this year, will slow growth, but it does not guarantee that a recession will occur.

Read more: Is the United States Heading for Another Recession?

But it’s better to be prepared than caught off guard, especially when it comes to your money.

Some people still feel the scars of the financial crisis of 2007 to 2009. Millennials who started their careers during this period discovered the worst job market in 80 years, Annie Lowrey noted for the Atlantic in 2019and have struggled to build wealth ever since.

Tom Blower, CFP, senior financial advisor at Fiduciary Financial Investors in Grand Rapids, Michigan, vividly recalls the experience of working with clients in 2008 and 2009 who lost their jobs and saw their investment portfolios shrink. the value.

“Every recession is a little different, but history has a way of repeating itself,” he says. “I always remind my clients not to think in terms of ‘this time is different’,” and he discourages them from trying to time the market.

You may not be able to completely protect yourself from the impact of a recession. But bolstering your finances when you have the cash can soften the blow in a downturn.

“Use the highs to put your financial situation in order, so that when the lows come, it’s just a minor inconvenience rather than a crisis,” says Tania Brown, CFP, financial coach at SaverLife, a fintech non-profit organization.

4 Ways to Strengthen Your Finances Long Before a Recession Hits

1. Build your emergency fund

Although conventional wisdom recommends putting three to six months of your essential expenses into an emergency fund, the pandemic has led some people to try to save more, up to a year of expenses, in some cases.

Whether you’re a super saver or struggling to catch up after the hardships of the pandemic, it’s more important to focus on the habit of saving than on the exact amount in your bank account.

Brown suggests reframing success as progress rather than a final achievement. “To me, saving $5 when you didn’t think you could is a much bigger win that will get you to your ultimate goal,” she says.

Read more: Here’s how the pandemic broke the rule of thumb for emergency savings

Beyond building up savings in an emergency fund, you also need to decide what type of emergency you will use your fund for and don’t be shy about doing so.

It’s something that Emmanuel Henson, CFP, founder and president of Gamma Wealth Management based in Towson, Maryland, often has to explain to clients: your emergency fund is there for you.

“Some people have a hard time understanding that they had to loot their funds and they take it personally,” Henson says. But when emergencies such as health issues and layoffs arise, “you don’t owe anyone an explanation.”

Remember that if you need to deplete your emergency savings at some point, you can eventually replenish that fund.

2. Pay off the debt

If you already have an emergency fund, it’s time to focus on paying off your debts.

You don’t need to plan to pay off your mortgage in 10 years instead of 30, or make huge student loan payments when federal loans are still in forbearance.

But any debt that has a double-digit interest rate or has a floating rate is worth trying to get off your plate as soon as possible. “Credit cards have variable rates that are already increasing,” warns Jay ZigmontCFP and founder of the financial advisory firm Live, Learn, Plan based in Water Valley, Mississippi.

The Federal Reserve plans to raise rates several times in 2022, which will lead credit card issuers to raise variable interest rates.

The average credit card APR has remained stable at around 16% for the past few years. If APRs start to climb, you’ll need to work harder to keep interest from piling up on your balance.

That’s just the national average – if you have less than perfect credit, you could easily be paying an average of 25% APR right now.

If you can hack and pay off your credit card or installment loan balance now, you can avoid having to use your emergency fund to pay those bills if your financial situation suddenly changes.

3. Master the lifestyle

It can be difficult to save on basic necessities in categories where inflation has driven prices up dramatically.

Instead of worrying about every penny you spend, take a look at your overall lifestyle. Is there anything you can cut back on that you really won’t miss?

If you got a raise during the pandemic, you may have found yourself mindlessly spending that extra cash rather than saving it or spending it on your financial priorities. Or you might realize that the money you’ve saved from having no more commuting is going towards more takeout and delivery.

It’s easier to cut expenses when you’re thinking about optimizing your finances, rather than when you’re in a defensive situation, such as dealing with a loss of income.

“People have become accustomed to a high growth, low interest environment, which has led to lifestyle drift for many,” Zigmont says. “When you add stimulus payments and student loan forbearance, the result is that many people are living beyond their means and having to adapt before times get tough.”

Read more: 6 tips for living your budget, not just planning it

Ryan Phillips, CFP, founder of GuidePoint Financial Planning in Reston, Va., encourages clients not to overwork themselves during the good times.

These days in particular, he urges caution for those considering big-ticket purchases like a house or car, or customers planning a home improvement project. “Given the current supply chain and inventory issues, there is a risk of overpaying for some of these items,” he says. Timber prices, for example, have increased by 150% during the pandemic. “When a recession finally hits, these are the things we can’t go back and undo.”

4. Feed your career

You may not be ready to take part in the Great Resignation and make a big career change. But even if you’re happy with your current work situation, it’s always a good idea to keep your resume up to date.

If you lose your job due to a major economic event, a strong resume can help you bounce back or transition into a new career.

“Take ownership of your career,” Brown says. “Take full advantage of free courses and certifications to keep your skills up to date. Update your LinkedIn profile to always be ready to work.

And while the job market is hot, it’s a good time to make sure you’re getting paid what you deserve. Research the market rate for your role and advocate for a raise if needed.

Then put that excess money to work strengthening your financial safety net.

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