The 11-year bull market in stocks recently came to an abrupt end, and even though a bear market does not always lead to a recession, they do tend to coincide to some degree. And with markets continuing to tumble, it’s looking like the U.S. stock market is pricing in a global recession.
While we are not saying a recession is imminent (there is no way to know that with 100% certainty), there is some merit to thinking about how to get you finances in the best possible position during these uncertain times. So, what are some steps you can take now to prepare for a possible economic recession?
Here are five steps to take now to help you prepare your personal finances for a recession:
1. Lower your debt.
When it comes to surviving financially during a recession, excess debt is like a millstone hanging around your neck. If not brought under control, debt can sink your personal finances by eliminating any flexibility in your monthly budget. We generally recommend lowering or even eliminating all high-interest debt. You should start by whittling down credit card debt, paying off the cards with the highest interest rate first.
However, this particular moment in history is unprecedented in many ways, one being that several credit card companies are offering some amount of debt relief to those experiencing hardship due to the COVID-19 situation. American Express, Bank of America, Capital One, and many other major credit card providers have said that they will support customers during this time, but many have remained vague as to how they will roll out this assistance and to whom. Most have said to reach out to the company, and they will provide support on a case-by-case basis. If you have questions about what your credit card company is offering in the way of debt relief, call the number on your monthly statement to discuss your situation.
2. Build up your emergency savings fund.
Having a solid emergency fund emergency fund will help you avoid a situation where you need to sell stocks that have dropped in value to pay for unexpected expenses. A common rule of thumb is to save between 3-6 months’ worth of non-discretionary living expenses in an emergency fund. This includes expenses like your mortgage or rent, utilities, insurance, groceries and transportation. For example, if your budgeted non-discretionary living expenses are $2,000 per month, your goal would be to accumulate between $6,000 and $12,000 in an emergency savings fund.
You should park your emergency funds in a 100% liquid account that is FDIC insured so you can access your money easily and penalty-free when you need it. Make sure you read the fine print when you’re choosing an account for your savings. While it’s great to earn interest on your emergency fund, your primary goal should be to keep the money safe and liquid. Some accounts will have withdrawal limits, restrictions or even hidden bank fees, so just make sure you’re aware of that before moving your money.
Personal Capital offers an online cash account, Personal Capital Cash™, which is FDIC insured and has flexible deposits and withdrawals.
3. Identify your discretionary expenses.
Now that we’ve discussed non-discretionary living expenses, it also makes sense to review your discretionary spending patterns in search of expenses that you could eliminate if you have to.
Excess subscriptions for everything from multiple streaming services to health clubs, to cable or satellite TV, to expensive cell phone plans are all items you should carefully scrutinize. Identify these types of discretionary expenses now and evaluate what you’d be willing to eliminate if you needed to tighten your belt for a while.
4. Live within your means.
In their effort to “live the American dream,” many people end up living beyond their means, especially in long bull markets where we become used to extended periods of economic stability. For example, they may buy a larger and more expensive house, drive more expensive cars, and take fancier vacations than they can really afford.
As you work on preparing your personal finances for a possible recession, seriously consider reducing some of your big-ticket expenses, like selling cars with high monthly payments in favor of less expensive options. While we’re not advocating an approach of compromising your lifestyle because you’re scared of market activity, it’s generally a good idea to take stock of what you can comfortably afford during a period of economic recession.
5. Don’t lose focus on the long-term.
While striving to reduce debt and maintain your emergency savings fund, it’s also important to not lose sight of your long-term financial goals — especially saving for retirement. Therefore, you should try to continue making regular contributions to your retirement savings account even while you’re paying down debt.
This is especially true if you receive matching 401k contributions from your employer. 401k matches are the closest thing there is to “free money” and represent a risk-free return on your investment. If your employer matches your contributions at a rate of 20 percent, that’s the same thing as a guaranteed 20 percent investment return.
And if you are able to, it’s great to max out or increase your 401k contributions when the markets are down. It gives you an opportunity to buy at a lower price, and over the years, compound interest should do wonders for your returns.
The bottom line is that whether or not you feel prepared and organized financially, it makes sense in times like these to practice some introspection. If you take a critical look at your finances now and follow these steps to prepare, you will have a good head start towards making sure you’re where you need to be to weather the storm.