Recessions are an inevitable part of the economic cycle.
But with proper planning, you can not only survive a recession but turn these challenging times into opportunities.
This guide provides six tangible strategies to help you prepare for and navigate a recession.
What Is a Recession?
The most widely-accepted technical definition of a recession is two consecutive quarters of negative economic growth.
But you can think of it as a period in the economic cycle characterized by a significant drop in the economy’s overall activity, such as gross domestic product (GDP), income, employment and production.
While a situation like this isn’t ideal, recessions are a regular part of the economic system. They occur every few years, though their exact timing and duration is impossible to predict.
For example, no experts were predicting a global pandemic at the start of 2020. And the 2008 financial crisis that led to the so-called Great Recession? Only a handful of people saw it coming.
So the right mindset is to focus on building a solid financial plan to weather any economic downturns.
7 Steps to Help You Prepare for a Recession
There are six practical steps that can help you safeguard your finances, overcome economic challenges, and thrive in any economic climate.
#1. Increase Your Emergency Fund
An emergency fund is a savings account set aside to cover unexpected expenses. Conventional wisdom suggests having three to six months of living expenses set aside at all times.
For those concerned about recessions and their potential impact, it might be necessary to increase your emergency savings to cover more than six months.
While there is an opportunity cost associated with increasing your emergency savings, as that money can be invested for potentially higher returns (i.e., you’ll typically get better returns putting your money in a mutual fund than a savings account), prioritizing financial security can have significant benefits.
By having a well-funded emergency fund, you can resist the urge to make hasty investment decisions driven by market volatility and instead make more informed choices that will allow you to thrive in the long term.
Circumstances where it might make sense to increase your emergency fund, regardless of your feelings about the economy, include having a job that’s highly dependent on economic conditions, such as roles in sales, real estate or business ownership.
These positions often see significant income variability, and a more substantial emergency fund can help absorb the financial impact of economic downturns.
#2. Recession-Proof Your Career and Income
To prepare for a recession, it’s smart to evaluate the potential impact on your career and income.
Start by reflecting on past recessions (like the 2008 financial crisis) to understand how your industry was affected, including the unemployment rate and layoffs.
Another angle is to assess the value you provide. If downsizing occurs, valuable employees are often retained. Consider your vulnerability compared to your peers; would you keep your job if the bottom 5% or bottom 20% were let go?
While some factors are beyond your control, there are many proactive steps you can take to strengthen your chances of maintaining your income during a recession.
For example, consider acquiring additional certifications or high-income skills to increase your marketability. You may even consider freelancing or starting a side hustle, not only to make extra money (i.e., to bolster your emergency fund) but also to diversify your income.
#3. Pay Off High-Interest Debt
Paying off high-interest debt has a number of benefits that allow you to better prepare for a recession.
- You’ll save money on interest. High-interest debt (i.e., credit card debt) can quickly accumulate due to compound interest, which means you pay interest on the interest you already owe. By paying off high-interest debt first, you can avoid this vicious cycle and reduce your overall debt burden.
- You’ll improve your cash flow. High-interest debt payments can eat up a large portion of your income, leaving you with less money for other expenses or savings. By eliminating high-interest debt, you can lower your overall monthly expenses and have more financial flexibility. This improved cash flow situation can also make saving easier.
- You’ll reduce your financial stress. High-interest debt can be a source of anxiety and uncertainty, especially during challenging times. By clearing high-interest debt, you can eliminate a major worry and enjoy your life with more confidence and happiness.
#4. Identify and Eliminate Sunk Costs
The sunk cost fallacy is a psychological phenomenon that causes us to justify our decisions based on the amount of time, effort and/or money we have already invested in something, rather than based on a realistic consideration of current and future value.
This can lead to poor financial choices, as we may hold onto underperforming assets or continue to hold on to assets that no longer provide the value to us they once did.
To break free from the sunk cost fallacy, ask yourself the following:
“If I knew what I know now, would I willingly repurchase this asset at its current selling price?”
If the answer is no, it may be time to cut your losses and move on.
For example, if you find yourself holding onto a stock that consistently underperforms or no longer aligns with your investment strategy, evaluate it objectively. If you wouldn’t invest in that stock again today, given your current knowledge and at today’s price, it’s best to sell it and reallocate the funds to an approach that better aligns with your goals.
Likewise, if you’re burdened by an expensive car that strains your budget, now is the best time to sell it and consider a more affordable option.
#5. Revisit Your Asset Allocation
Many people are overly aggressive with their investments during prosperous periods, leading to the need for drastic corrections when times are tough.
The best approach is to have a strategy that is designed to weather both prosperous and challenging times.
In other words, your asset allocation shouldn’t change during a recession, it should remain steady in all economic environments.
Or, as the late Jack Bogle (the founder of Vanguard) said about investing during a recession, “Don’t do something. Just stand there.”
One valuable tip is to utilize tools like the Empower investment checkup tool, which provides a free assessment of your portfolio’s optimization.
This can help determine if your asset allocation aligns with the efficient frontier, a concept that represents the optimal balance between risk and return.
The end goal is to create an investment strategy that avoids you having to make impulsive decisions based on the short-term market volatility that often accompanies an overall economic downturn.
#6. Increase Your Credit Score
Having a strong credit score gives you more options during a recession, which is a time when you may need them the most.
For example, you may be able to qualify for a 0% interest rate credit card in the midst of a recession, or get a personal loan that can help you stay afloat.
Moreover, as interest rates tend to decrease during a recession, a high credit score now may open up opportunities like refinancing your mortgage.
The best practices to increase your credit score are to:
- Pay your bills on time. Consistently making timely payments is one of the most effective ways to improve your credit score. Set up payment reminders or automatic payments to avoid missing due dates.
- Reduce credit utilization. Aim to keep your credit utilization ratio — the amount of credit you use compared to your total available credit — as low as possible. Ideally, keep it below 30% to demonstrate responsible credit management.
- Increase credit limits. Requesting credit limit increases on your existing credit cards can provide you with access to additional funds if needed. This can be helpful during a recession when having extra financial resources is crucial. It can also help reduce credit utilization as well. While the goal is to never rely on credit cards, having an extra buffer can help cover you in times of an emergency.
See our comprehensive list of the best free credit score and credit monitoring apps.
#7. Create a Financial Ritual
A financial ritual is a regular check-in where you evaluate your finances and assess your progress toward your financial goals. This isn’t something you want to start in a recession when things can get stressful, but rather a habit you want to cultivate well before.
A good timeframe for regular financial check-ins is once a month.
For couples, having a financial ritual is even more important, as this is the time to discuss your financial progress and get on the same page. When a recession hits, couples must work together to weather the storm and navigate any financial challenges that may arise.
A strong financial ritual established before the recession ensures that both partners agree about their financial goals and strategies.
Your monthly financial ritual may consist of different tasks depending on your financial goals and situation. Personally, I find what works best is tracking a handful of important indicators that give you feedback on your current goals — things like net worth, progress towards paying off debt, portfolio value, etc. — talking about how you did last month (how much you spent, how much you saved, etc.), and what’s ahead in terms of big expenses.
From there, make any necessary changes based on the conversation.
How to Prepare for a Recession: Summary and Final Thoughts
Recessions are not fun. But then again, that’s why you plan for an economic downturn — so the pain doesn’t hit you quite so hard.
This is where that emergency fund comes into play, and where that properly-balanced portfolio gets you through.
Ups and downs are normal. No economy grows forever, uninterrupted and with no bumps in the road. That’s just not how economies work. But there has never been a recession or a bear market that we haven’t recovered from.
We recovered from the Great Depression. We recovered from the last recession. And we’ll recover from the next recession, whenever it arrives.
So the key is to stay focused on your financial goals and to make sure you have enough savings to cover your monthly expenses in the case of an unexpected financial emergency (such as a sudden job loss).
Doing this, along with implementing some of the other strategies outlined above, will help you weather a short-term economic downturn — and can even improve your long-term financial outlook.