Prices continue rising, and high inflation often comes before an economic recession. It’s not surprising that more than half of Americans (60%) are worried that a major recession is right around the corner, according to a recent survey. They may be correct: In its latest Global Economic Prospects Report, the World Bank predicts that much of the world is headed for a recession.
Most of us can’t change the direction of the economy, but we can change the direction of our own finances. And right now is a good time to take a hard look at your financial situation and prepare for a potential downturn.
What Is a Recession?
A recession is a significant decline in economic activity. Usually, it involves a lot of people losing their jobs, companies making fewer sales and cutting back on bonuses and raises.
Technically, a recession is defined as two consecutive quarters of negative economic growth. The U.S. economy shrank by 1.4% in the first quarter of this year, so if the economy shrinks again during the second quarter, we’ll be in a recession.
Even if we don’t reach a technical recession, we’re likely to experience an economic downturn, which is a general slowdown in economic activity over a sustained period of time. To manage successfully, it’s important to be prepared.
How to Be Prepared
Ups and downs are a natural part of a modern economy. But the downturns won’t be as painful if you have taken steps to prepare your own financial situation. Consider these six ways to ready your finances for a potential recession or downturn.
Rein in lifestyle spending. During economic boom times, when people are making more money, lifestyle creep is common. That’s a steady expansion of your standard of living as your discretionary income rises. For example, things you once viewed as luxuries gradually become seen as necessities or standards. That could be dining out daily or weekly, purchasing more expensive cars or regularly updating your wardrobe.
Before the economy turns, take a look at your standard of living and figure out what you can cut. You may not need to deprive yourself; you just need to adjust your thinking about what expenses are truly necessary—and limit your spending on unnecessary items.
Avoid taking on new credit. Considering taking out a loan for a new luxury car or a home remodel based on your current income? Now might be the time to purchase a less expensive car or drive your current vehicle a little longer, or delay the remodeling project. If you work on commission, depend on bonuses, or work in a company that could suffer during a recession, your income could drop drastically during an economic downturn—and making those payments could become difficult.
Build your emergency fund. Experts have traditionally recommended aiming to save three to six months’ worth of income in an emergency account. But during the COVID-19 pandemic, many people needed an even bigger emergency fund. A normal economic downturn won’t be as devastating as the pandemic was for many people, but it’s wise to be prepared with emergency cash on hand. Start now to sock away as much as possible so you’ll be prepared.
Pay down existing debt. If you have outstanding credit card or other consumer debt, especially if the interest rate is adjustable, work to pay down as much as you can. Interest rates are already rising and are likely to continue. Rather than paying higher and higher interest rates on purchases you’ve already made, work to pay off the debt—and you’ll have more money available for savings or for living expenses in case your income drops.
Focus on your career. One of the hallmarks of a recession or economic downturn is an increase in layoffs and salary cuts. Hopefully you can avoid both, but it’s never a bad idea to take advantage of learning new skills, updating your resume, and boosting your marketability. That way, you’ll be prepared if you need to look for a new job—and you’ll be more effective in your current position.
If you think your job may be at risk in a recession, now may be a good time to look for a new position. With the current labor shortage, many employers are offering higher salaries to attract workers, so you may be able to get a job with higher pay.
Monitor your credit. You may not be planning to take on new credit, but if you encounter a financial emergency, it may be necessary to take out a home equity loan or other form of financing. Keep track of your credit scores and reports now instead of waiting until you need to use your credit. If there are errors on your reports, getting them removed can take time. By keeping track of your credit now, you’ll be prepared when you need to use it.
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