How to Prepare Your Personal Finances for a Recession

The booming U.S. economy recently set a new record when the long-running expansion reached 121 months, breaking the previous record of 120 months set between March 1991 and March 2001, according to the National Bureau of Economic Research (NBER).

Of course, this is good news. But the reality is that all economic expansions eventually end — and there are signs that the current expansion could be running out of steam. While we are not predicting a recession by any means (trying to predict market and economic activity is always going to be a fool’s errand), there is definitely some merit to thinking about how to get yourself in the best place possible with your personal finances. So what can you do to prepare for an economic recession when it eventually occurs?

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, this debt can sink your personal finances by eliminating any wiggle room in your monthly budget.

Some financial experts recommend lowering, or even better eliminating, all personal debt except a home mortgage. You should start by whittling down high-interest credit card debt. It’s usually a good idea to start paying off the cards with the highest interest first.

Next, focus on any personal or student loan debt you may be carrying. If you have significant student loan debt, you might consider refinancing in order to shorten the amortization schedule and get them paid off faster. However, if you have a Federal student loan, make sure you consult a fiduciary professional to see if refinancing is the right option, as sometimes it’s actually best not to refinance Federal loans. Also, try to pay off any personal loans you may have outstanding, like car loans. This is especially true if you have a long-term car loan of six or seven years or a variable rate car loan.

2. Build up your emergency savings fund.

Having a solid emergency fund will help you avoid a situation where you need to sell stocks to pay for unexpected expenses when they might be significantly down. A common rule of thumb is to save between three- and six-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 percent liquid account like a high-yield account 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, as while it’s great to earn interest on your emergency fund, your goal should be to keep the money safe and liquid. Sometimes accounts will have withdrawal limits or restrictions, so just make sure you’re aware of that before moving your money.

3. Identify your discretionary expenses.

You’ll notice that I referred to non-discretionary living expenses in the previous step, but now is also the time to review your spending patterns in search of money that you spend on discretionary expenses that you could eliminate if you had to.

For most people, this includes things like eating out at restaurants, going to movies and concerts, and other types of entertainment. Excess subscriptions for everything from multiple streaming services to health clubs, to cable or satellite TV, to expensive cell phone plans should also be carefully scrutinized. By identifying these discretionary expenses now, you can better plan for what you’d be willing to eliminate if you need to in the future.

Read More: How to Master a Household Budget

4. Live within your means.

In their effort to “live the American dream” and “keep up with the Joneses,” many people end up living beyond their means. For example, they 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 the end of the bull market, seriously consider whether you could benefit from downsizing to a smaller home or 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 really, comfortably afford. Doing this now could make you a lot less vulnerable to a recession when one finally occurs.

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. So if your employer matches your contributions at a rate of 50 percent, that’s the same thing as a guaranteed 50 percent investment return.

It’s also not a good idea to make a knee-jerk reaction when you start to see the market go downhill. Take a deep breath, call your financial advisor, and talk it out. It’s almost never beneficial to your long-term financial success to liquidate or sell when the market is taking a nosedive.

Forecasting exactly when recessions will occur is tricky business. But one thing is certain: A recession will occur eventually — whether it’s next year or several years down the road. But regardless of when a recession may or may not happen, these are some good strategies to help get your personal finances in the best possible place.

Disclaimer: The information on this website is for informational purposes only and does not constitute a complete description of our investment services or performance. No part of this site nor the links contained therein is a solicitation or offer to sell securities or investment advisory services, except where applicable in states where we are registered, or where an exemption or exclusion from such registration exists. Third party data is obtained from sources believed to be reliable. However, Personal Capital Advisors Corporation cannot guarantee that data’s currency, accuracy, timeliness, completeness or fitness for any particular purpose. Certain sections of this commentary may contain forward-looking statements that are based on our reasonable expectations, estimate, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

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