7 ways to recession-proof your finances
7 Ways To Recession-Proof Your Finances

The U.S. economy may have just staged its fastest recovery from a recession in history — a notable feat after a crisis as catastrophic as the coronavirus pandemic — but that rebound hasn’t stopped forecasters, investors and consumers alike from fearing that another downturn is around the corner.

As inflation soars to a 40-year high, consumer confidence dips and the Federal Reserve looks on track to hike rates at the fastest pace since 2005, economists’ top concern is that the rug might be ripped out from underneath the U.S. financial system, pulling away too much stimulus at a time when demand could also falter.

Economists in Bankrate’s First-Quarter Economic Indicator poll said there’s a 1-in-3 chance that the economy could contract at some point within the next 12 to 18 months. Meanwhile, 10-year Treasury yields traded above the 2-year rate in March for the first time since 2019, causing the closely watched yield curve to invert — a frequently watched recession indicator.

Recessions don’t just matter for economic models. They often spell financial trouble for consumers, either in the form of job loss or pay cuts. One of the most troubling facts of life is that downturns are inevitable, reflecting the cyclical nature of the economy.

All of that’s to say, preparing your wallet for harsh economic times is an essential part of your financial health, downturn or not. Here are seven tips to help make sure your finances are recession-proof, as recommended by experts.

1. Pay down high-interest credit card balances

When emergencies hit, you’ll want to eliminate as many of your monthly expenses as possible — and among the costliest ones for your budget are high-interest debt payments. That is even more true at a time when the Federal Reserve is likely to lift its key borrowing benchmark seven times this year. The Fed’s interest rate — known as the federal funds rate — influences all other forms of short-term borrowing.

High-interest debt commonly comes from a credit card. Even when the Fed’s rate was at its lowest, the average credit card annual percentage rate (APR) hovered close to 16 percent, according to Bankrate data. Carrying a balance from month to month could potentially cost you hundreds, if not thousands, more a month.

Eliminating that debt could free up crucial breathing room in your budget that you could use to bolster your emergency fund. A February 2022 Bankrate poll found that 22 percent of Americans have more credit card debt than savings.

“Being in a position where you’ve eliminated those types of high-cost obligations allows you to better prepare for other things financially,” says Lauren Anastasio, CFP, director of financial advice at Stash. “The more you’re able to put aside for saving and the less debt you have, it’s going to be available to you in case of an emergency.”

Use Bankrate’s tools to calculate a debt-payoff plan or take advantage of balance-transfer credit cards with zero percent intro APRs.

2. Assess your individual financial situation before paying off other debt

U.S. households have more than just credit card debt. Americans also have $10.93 trillion total in mortgage debt, $1.58 trillion in student loan debt, $1.46 trillion worth of auto loans and $318 billion on home equity lines of credit (HELOCs), according to the New York Fed’s survey of household debt and credit for the first quarter of 2022.

But it might not make sense for consumers to concentrate on paying down debts that have relatively lower interest rates and attractive provisions. One such example could be student loans, according to Greg McBride, CFA, Bankrate chief financial analyst. Borrowers are often able to negotiate a temporary payment plan or apply for forbearance in the event of unexpected job loss, though rules differ for private lenders. Another case in point: Federal borrowers’ payments have been on pause for more than two years, in light of the coronavirus pandemic.

Take a look at your emergency fund. If you don’t have much cash that you could use in the event of unexpected job loss, you might want to consider allocating any extra money toward your savings account instead. A lack of savings might be another reason why a consumer keeps incurring credit card debt. A January Bankrate poll found that less than half of Americans (or 44 percent) could cover an unplanned $1,000 expense with their savings.

“If an emergency arises and you’re putting every dollar toward eliminating debt, you have no choice but to go back to credit cards to cover the expense,” Anastasio says. “Everyone needs to have a cash cushion.”

Financial experts recommend storing six months’ worth of expenses in a liquid and accessible account as a crucial cushion to cover emergencies, job loss or pay cuts.

3. Build a substantial emergency fund

Jobless Americans can often turn to unemployment insurance (UI) for help with income. How much each individual receives depends on the state, but generally about 30 to 50 percent of workers’ wages are replaced with the assistance program, according to the National Bureau of Economic Research. That’s unless Congress enhances the program, as lawmakers did during the coronavirus pandemic.

Assembling six months’ worth of expenses can seem like a daunting task, but don’t underestimate the power of small contributions. Regularly adding to your savings account over time can build the crucial savings habit. Better yet, automate your contributions to put the process on autopilot. For more tips, take Bankrate’s free financial education course on building your emergency fund.

Next comes the important step of deciding where to park your cash. Savings accounts from online banks often offer yields that are 10 times the national average. Shop around for the best account that suits your needs and lifestyle.

4. Identify ways to cut back

If you’re looking to free up cash that you can recycle back into your savings account, it’s always a good idea to go through your monthly expenses and identify which items are discretionary — services or items you can live without — and which items are a necessity. The discretionary items are most likely ones that you can either eliminate now or in the future.

Experts typically recommend spending no more than 30 percent of your net income (that is, earnings after taxes) on discretionary items. It’s a good idea to create a monthly budget to ensure that you’re living within your means and not overspending. Doing so when the economy is strong could help set you up for success during bad economic times.

“You have to pay your rent; you have to pay your car insurance; you have to eat to live. Your groceries, your utilities — those are all going to be essential expenses,” Anastasio says. “But dining out, vacations, cable — anything that you would potentially consider a luxury or a lifestyle expense — that’s discretionary spending.”

5. Don’t make knee-jerk reactions with your investments

A downturn might seem synonymous with a plunging stock market since companies often find it hard to hire, expand and invest when times are tough. Even worse, they might decide to start laying workers off.

But changing your strategy during a recession would be the worst thing you could do, McBride says. That goes for all individuals: whether they’re 20 or just two years away from retiring.

“It will take a tough stomach because in a recession a stock market will easily fall 30 to 40 percent, peak to trough, but making regular contributions and reinvesting all of the distributions will make those market gyrations work to your benefit,” McBride says. “A recession is a tremendous buying opportunity.”

If you’re planning to retire in the next few years, consider having your first few years of withdrawals already on hand, in cash. But even then, don’t shy away from keeping equities in your portfolio. Those are often where you’ll get the best returns adjusted for inflation — a concern that many Americans are having to grapple with, after prices in February soared by the fastest rate in 40 years.

“Do not make changes that jeopardize your long-term financial security based on short-term economic events,” McBride says. “Even for someone who is on the cusp of retirement, retirement is going to last 25 to 30 years. A recession is going to last a year.”

Even so, the market doesn’t always behave the way you’d expect it. After plunging nearly 31 percent in March 20, 2020, the S&P 500 took off like a rocket during the coronavirus pandemic, hitting 70 fresh all-time highs in 2021 alone, despite the economy being in the worst recession since the Great Depression. A large part of that was the Fed’s go-big-or-go-home efforts to revive the ailing economy, which instilled confidence in investors.

6. Think about your career and earnings opportunities 

To recession-proof your career, one of the best investments you can make is pursuing an education, says Tara Sinclair, an economics professor at George Washington University and a senior fellow at Indeed’s Hiring Lab.

During recessions, the unemployment rate for those with a bachelor’s degree or higher is much lower than for those who have a high school education or less. About 2 percent of workers with a bachelor’s degree or higher were unemployed in March, compared with 4 percent of high school graduates and 5.2 percent of those without a high school diploma, according to the Department of Labor.

Networking and maintaining strong connections with workers in your field could also help you find new opportunities. Better yet, strengthening your skill sets and pursuing more training could make you more marketable in your field.

Consumers might also be able to use today’s robust labor market to their advantage. Joblessness is near a half-decade low, and employers have been looking to fill a near record number of jobs for 13 straight months. Companies are responding to the labor shortage by boosting wages.

People who switched to a new job were able to secure the highest pay gains in the year, with their wages up 5 percent from a year ago, compared with 3.8 percent for job-stayers, according to the Atlanta Fed’s Wage Growth Tracker.

That extra cash could be a crucial way to bolster your income at a time when consumers are losing their purchasing power at the fastest rate since 1982. That extra cash you earn could also be deposited back into your savings.

“Economists are always emphasizing the importance of education,” Sinclair says. “Even if you can’t build up a financial buffer, focusing on making sure that you have some training and skills that are broadly going to be employable is really crucial.”

7. Don’t panic: Recessions are inevitable, but they’re not always as bad as the coronavirus pandemic or the Great Recession

“Recession” is a scary word for the Americans who’ve lived through two back-to-back, once-in-a-lifetime recessions: the coronavirus pandemic and the Great Recession before it.

Even worse, attempting to predict downturns will set even the experts up for failure. No event illustrates that more than the coronavirus crisis. At the beginning of 2020, economists hadn’t even considered that a global outbreak could wreck the U.S. economy’s longest expansion on record.

Though most economists would lump the two causes of recessions into supply shocks or demand shocks, each of the past 33 recessions (as tracked by the NBER Business Cycle Dating Committee) have been caused by something a little different, Sinclair says.

“Some people say economists exist to make weather forecasters look good,” Sinclair says. “The complexity of the macro economy is such that we haven’t yet figured out a clear, causal model of how things work. We can’t predict with any kind of confidence what’s going to happen, particularly when things are changing dramatically. Obviously, if recessions were easily predictable and preventable, we’d expect policymakers to be doing just that.”

The most basic definition of a recession is a drop in output for two consecutive quarters. Simply put, the start of a recession is the point at which the economy is contracting, not growing.

But not all downturns crater U.S. economic growth and cause double-digit unemployment. In the aftermath of a recession in the early 2000s, nationwide unemployment peaked at 6.3 percent. The recession before that, joblessness rose to a high of 7.8 percent.

Taking steps to prepare your wallet for a downturn when times are good can help take away some of the stress and worry surrounding recessions. And rest assured: Even if economists can’t predict recessions, they almost always know when the U.S. economy is in the middle of one.

“I don’t think there’s ever a bad time to evaluate their finances and check in with themselves,” Anastasio says. “If someone personally feels nervous that there’s change on the horizon, it’s always a good time to say, ‘What can I do personally to put myself in a stronger financial position, so I can sleep better at night when the time comes.’”

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