Recessions are arguably inevitable in modern capitalist economies, occurring roughly every 10 years. Keep reading as I share some tips regarding how to prepare for a recession so you can weather – or even rise above – the turmoil.
What is a recession?
The U.S. National Bureau of Economic Research (NBER) defines a recession as a sharp decline in economic activity lasting more than a few months and spread throughout the entire economy.
The hallmarks of a recession are typically visible in a few key metrics, including:
- real gross domestic product (GDP)
- real income
- employment rates
- wholesale-retail sales
- production
As of writing, the NBER’s last declaration of a recession pertained to the period of February 2020 to April 2020. At just two months, it was the shortest U.S. recession in recorded history.
No matter how short a recession is, though, its impact can still devastate millions of people. Indeed, the COVID-fueled recession of 2020 was a stark reminder of how important it is to be prepared.
How to prepare for a recession: 8 essential tips
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1. Establish an emergency fund
Having an emergency fund can be an incredible source of relief before and during a recession.
After all, keep in mind that high unemployment rates are a hallmark of recessions. During the 2008 financial crisis, unemployment peaked at 10%. In 2020, it hit 13%.
If you’re among the unfortunate few that find themselves out of work amid the next recession, you’ll definitely want an emergency fund to fall back on.
Most experts recommend maintaining an emergency fund capable of covering your essential expenses for the next three to six months. Check out this article for some tips on planning for unexpected expenses if you’d like to plan more granularly.
2. Build a strong skill stack
“Skill stacking” is the practice of combining various skills to make yourself uniquely attractive to prospective employers. This can make all the difference when you’re looking for a new job (or trying to keep your current one) amid a recession.
You don’t need to have expert-level knowledge in dozens of areas. In fact, many business problems can be solved by people with soft skills and a decent working knowledge of the subject matter.
That’s how I landed my first job in software. I demonstrated my ability to communicate complex technical concepts effectively despite not being an expert in each of them. That’s a skill I learned dealing with clients in the seemingly unrelated field of marketing.
If you’re not sure where to start, check out this article for a list of recession-proof jobs and consider learning the skills associated with whichever ones interest you.
3. Invest wisely
The worst thing that could happen to you as an investor during a recession is that you lose faith in your portfolio and sell at the worst possible time. This often happens because of poor investment decisions made during strong economic times.
One common bad decision is purchasing highly speculative assets. When the market is booming, these assets seem great. But when a recession hits, any illusion of value evaporates and you’re left holding a flaming bag of smelly dung.
Another equally common (yet often overlooked) bad decision is over-investing. I’ve seen many people online insist they don’t need an emergency fund and would rather pump that money into the market. Again, this seems like a great decision when markets are booming. But when everything is collapsing and your employment seems uncertain, you’ll likely lose faith in your assets and sell at the worst time to free up cash.
A third mistake is over-exposure. That’s when you fail to diversify your portfolio. The risk here is that the assets you’re over-exposed to fall sharply and cause a steeper loss than you’d have otherwise experienced. This can spook you into selling at the bottom.
Avoiding behaviors like these is key when you’re looking into how to prepare for a recession. My approach is to invest the bulk of my money in a diversified set of broad market index funds. I also only invest money I’m prepared to leave untouched for at least 20 years.
4. Learn about investor psychology
There’s a lot more to investing than merely choosing assets and watching them increase in value. Your journey as an investor will involve many ups and downs. During a recession, you may lose money for months on end.
Making it through that without panic selling takes a certain mindset. You won’t develop that mindset overnight, either. You need context, which can only be gained through reading and learning about investor psychology. You’re better off doing that long before a recession.
I spent lots of time in 2019 doing just that. Specifically, Investing and the Irrational Mind was a great read. Capitalism in America also provided valuable historical context.
The financial turmoil of 2020 would’ve freaked me out a lot more if it wasn’t for those two books.
5. Live below your means
It’s easy to live more lavishly than you should (perhaps due to lifestyle creep) when the economy is strong. That habit will devastate your finances when money becomes scarce, though – particularly if you fund your lavish lifestyle using consumer debt.
You’d be much better off getting in the habit of living below your means as early as possible. In other words, buy less than you can afford.
For example, if the bank approves you for a $700,000 mortgage but those monthly payments would constrict your budget, buy a cheaper house. The same goes for vehicles and just about anything else.
When you live below your means, you increase the amount of flexibility you’ll have in the event of some adverse event (i.e. job loss amid a recession).
6. Eliminate high-interest debt
When you’re on stormy seas, the last thing you need is a leak in your boat. That’s exactly what high-interest debt is, though – a leak that gets worse the longer you leave it unplugged. That’s why a key part of how to prepare for a recession is eliminating high-interest debt.
There are a few tried and true strategies for achieving this. One is called the debt snowball method, which involves prioritizing your debt balances in order of smallest to largest. This will help you feel like you’re building momentum. Another approach is called the debt avalanche method. It involves tackling debt in order of highest interest rate to lowest.
Whichever approach you take, obliterating high-interest debt will provide peace of mind and financial flexibility during the next recession.
7. Build alternative sources of income
Relying on a single source of income to pay your bills is always a risky bet. When market conditions change, that revenue stream could dry up and leave you hanging.
Thankfully, setting up other income streams outside of your primary job isn’t rocket science. Check out this article, in which I list a few. To summarize, they include:
- selling digital products
- blogging
- selling homemade goods
- flipping used items for profit
- renting out part of your home
- Amazon Kindle Direct Publishing
Even a few extra hundred dollars coming in each month can be helpful.
8. Familiarize yourself with relevant assistance programs
Depending on your financial situation, you may qualify for government assistance (i.e. through unemployment) in the event of job loss during a recession. If you live in the United States, check out Benefits.gov to see what programs might apply to you. If you’re north of the border, check out the Canadian government’s website here.
Even if you don’t need assistance right now, knowing where to turn when times get rough will save you time.
How to prepare for a recession: Conclusion
Recessions can be scary. However, I hope the tips in this article have helped you understand the many ways you can prepare for a recession and not only survive but thrive through economic hardship.
Check out my other articles on the topic of financial planning here.
