How to Prepare Your Finances for a Recession

These days, it can be hard to avoid thinking about the possibility of an economic recession, as many are already feeling a lot of financial pain—mainly, from high inflation. But taking the right steps can help you better weather uncertain financial times.

“Given our last two recession were so severe, fear over the coming one is unusually high. But fear can push us to make rash decisions, and preparation can put you in control and ease anxieties,” shared Robert Frick, Navy Federal’s corporate economist, an expert in personal finance.

What Is a Recession?

A recession means the economy shrinks, rather than grows. Technically, that means the economy shrinks 2 quarters in a row, and it always means a rise in unemployment with a decline in corporate profits. At the same time, people spend less and the stock market generally drops.

The main worries during recession are sudden unemployment or reduced work hours—which can  make paying bills especially tough. If you have investments, a recession may cause their value to decline. You may even find it tougher to get credit and face higher interest rates if you’re approved.  

The basic steps to prepare are to manage your debt, build a financial cushion and secure your income streams.

If you have investments, such as through a retirement plan, you’ll only want to tap into them as a last resort, but you should understand how they may be used in an emergency.

Many Americans are already cutting back on spending in an effort to build up savings ahead of any economic downturn. But there are other steps you can take to prepare and strengthen your finances—let’s explore 4 strong options below.

Option 1: Take a Financial Inventory

Make a list of your income, expenses and debts. Most people don’t do a formal budget, which is time consuming, and can be frustrating because expenses vary so much month-to-month. Start by writing down your fixed monthly expenses, including mortgage, utility and car payments. Then you can take a look at how much extra you pay for unexpected expenses, such as car repairs.

Before looking at your sources of income, see where you can cut expenses. This includes unsubscribing to a streaming service you may not use or limiting how often you eat out. There may be big expenses, too such as payments on a car or boat that you could do without and could sell for a source of income. Can you consolidate debts to a lower interest rate? Pare back those expenses and come up with your recession-prep budget.

Now, compare the remaining expenses to your income. If you still have more than you’d like, it may be time to cut down on those things you want, but don’t necessarily need. Set up an automatic savings plan, if you can, to put some extra income into a secure savings account to help build for the future.

Option 2: Save For Emergencies

An important part of every savings plan is to have an emergency savings account. This is to keep you financially whole if you lose your job, so you can keep paying bills and not put car ownership or even home ownership at risk. If you’re a member of a household with two or more people earning paychecks, you’ll want to save enough to help cover at least 4 months’ worth of expenses.

This needs to be cash you can easily access—not in investments or from selling things you already have. During recessions, the value of not only stocks and bonds may fall, but so would the prices of things such as collectables. It might be tempting to reach into your emergency savings account for something you might simply want. But it’s far more important to let it be, and continue building for the proverbial “rainy day.”

• Savings accounts are the best place to keep your emergency fund. High-yield savings accounts let you earn interest on your savings while keeping your cash accessible.
• Certificates are another savings vehicle that offer higher yields and consistent returns. However, certificates are less accessible than savings accounts, and you may pay a penalty lose the dividends you’ve accrued if you tap into them before they come due.  
• Checking accounts are best for keeping cash you need to use frequently. Some checking accounts can earn you interest, although the dividends are usually lower than the average savings account. 

Option 3: Manage Debt

Generally speaking, you’ll want to pay down debt before financial hard times arrive. This not only reduces the interest you’ll pay on the debt in the long run, but could give you room to increase debt in case of a financial squeeze.

Consider paying off high-interest debt first. Loans and lines of credit with high interest rates can cost you more in the long term, and you could use that extra money to put toward savings or emergency uses. A recession isn’t the time to take on new debt unless it’s absolutely necessary. Do you really need a new car? Or can you get by with your existing car until the recession passes?

Should you sacrifice savings to pay down debt? Generally speaking, yes. By paying down debt, you can save on interest charges, and you could consider increasing debt again in emergencies. Ideally, you have low debt as well as savings, but that’s obviously not always possible. 

If your loan has a low interest rate or flexible repayment terms, it might be smarter to continue with standard repayment and save your extra cash in a savings account. Use a calculator like Navy Federal’s to determine whether paying off debt or saving will be better for your wallet.

And speaking of debt, If you own a home, you could even consider applying for a home equity line of credit with your bank or credit union. The line of credit could be a source of relatively cheap (lower interest rate) funds in an emergency. 

Option 4: Invest Carefully

The stock market can drop steeply during a recession, but we’ve already seen a big decline and a partial recovery since peaking in late 2021. If that didn’t convince you to sell, you’ll probably be fine with whatever effect on the markets the coming recession will have. A good way to avoid unnecessarily selling is to have your investments in broad-based index funds or target-date funds. By not seeing the ups and down of individual stocks, it could remove the temptation to try to beat the market. The market always recovers—but investors who unnecessarily sell rarely do.

Selling investments such as stocks should only be a very last resort. These are meant to meet long-term goals, and selling can endanger everything from retirement nest eggs to down payments for a house to college funds.

Build a Safer Financial Future

Taking these steps can help you deal with the financial pressures that may come to you or your family during a recession. And by taking control of your finances, you’re much less likely to make poor decisions under pressure. Evaluate your income, spending, debt and investment strategies now, so you can set yourself up for a healthier financial future.

For additional help preparing your finances for economic uncertainty, turn to the experts.