Recently skyrocketing oil and gas prices, continued record inflation, and the first of a potential slew of interest rate hikes have led some experts to wonder if a recession is on the horizon.
Although the Covid-19 recession from February to April 2020 was significantly shorter than the average recession (the average is 11 months according to a Jan. 2022 report from the Congressional Research Service), there have been long-ranging financial effects for many Americans.
Some households were able to weather the pandemic thanks to job security and stimulus payments. Others may still be rebuilding their finances in a post-vaccination landscape.
Regardless of which camp you’re in, if you lived through the Great Recession or any of its predecessors, even the faintest rumors of a recession may have you nervous about your financial health.
You can’t predict the future, but you can take steps to fortify your finances so you’re prepared in the event of a downturn.
Is a Recession Really That Likely?
The U.S. economy goes through cyclical patterns, with good and bad periods both inevitable.
But the growing economy (generally measured as the gross domestic product, or GDP) and strong labor market are two major indicators that our economy is in good shape, and a recession is not imminent.
Raising rates to tamp down inflation, as the Federal Reserve plans to do several times this year, will slow growth, but it doesn’t guarantee a recession will happen.
But it’s better to be prepared than caught off guard, especially when it comes to your money.
Some people are still feeling the scars of the financial crisis of 2007 to 2009. Millennials entering their careers during that period discovered the worst job market in 80 years, Annie Lowrey noted for the Atlantic in 2019, and have struggled to build wealth ever since.
Tom Blower, CFP, a senior financial advisor at Fiduciary Financial Investors in Grand Rapids, Michigan, can vividly recall the experience of working with clients in 2008 and 2009 who were experiencing job loss and watching their investment portfolios lose value.
“Each recession is a little different, but history has a way of repeating itself,” he says. “I always remind my clients not to think in terms of ‘this time is different’,” and he discourages them from trying to time the market.
You may not be able to fully protect yourself from the impact of a recession. But bolstering your finances when you have the money to do so can soften the blow when a downturn develops.
“Use the highs to get your financial house in order, so when the lows come it’s simply a minor inconvenience rather than a crisis,” says Tania Brown, CFP, a financial coach at financial technology nonprofit SaverLife.
4 Ways to Strengthen Your Finances Long Before a Recession Occurs
1. Build Your Emergency Fund
Though conventional wisdom recommends having three to six months of your essential expenses tucked away in an emergency fund, the pandemic has led some people to try to save more—up to a year’s expenses, in some cases.
Whether you’re a super saver or having a hard time catching up after pandemic hardships, it’s more important to focus on the habit of saving than the exact amount in your bank account.
Brown suggests reframing success as progress, rather than a final achievement. “Saving $5 when you didn’t think you could, to me, is a much bigger victory that will lead to your ultimate goal,” she says.
Beyond building savings in an emergency fund, you should also decide what type of emergencies you’ll tap your fund for—and not be reluctant to do so.
That’s one thing Emmanuel Henson, CFP, founder and president of Gamma Wealth Management based in Towson, Maryland, often has to explain to clients: Your emergency fund is there for you to use.
“Some people have a hard time coming to grips that they had to raid their funds and they take it personally,” Henson says. But when emergencies like health issues and layoffs crop up, “You don’t owe anyone an explanation.”
Remember that if you need to deplete your emergency savings at some point, you’ll eventually be able to rebuild that fund.
2. Pay Down Debt
If you already have an emergency fund, it’s time to focus on paying down debt.
You don’t need to make plans to pay off your mortgage in 10 years instead of 30, nor do you need to make huge student loan payments when federal loans are still in forbearance.
But any debt that has an interest rate in the double digits or has a variable rate is worth trying to get off your plate as soon as possible. “Credit cards have variable rates that are already going up,” warns Jay Zigmont, a CFP and founder of financial advising firm Live, Learn, Plan based in Water Valley, Mississippi.
The Federal Reserve anticipates raising rates several times in 2022, which will lead credit card issuers to raise variable interest rates.
The average credit card APR has been steady at about 16% for the past few years. If APRs start to creep up, you’ll have to work harder to keep interest from accumulating on your balance.
That’s just the national average—if you have less-than-perfect credit, you could easily pay an average of 25% APR right now.
If you can hack away and pay off your credit card or installment loan balances now, you can avoid having to use your emergency fund to pay those bills if there’s a sudden change to your financial situation.
3. Rein in Lifestyle Creep
It may be hard to save on necessities in categories where inflation has caused prices to rise dramatically.
Instead of worrying about each nickel and dime you spend, take a look at your overall lifestyle. Is there anything you can cut back on that you won’t really miss?
If you’ve gotten a raise during the pandemic, you may have found yourself spending that additional money thoughtlessly rather than saving it or putting it toward your financial priorities. Or you might realize the money you’ve saved by no longer having a daily commute is going toward more takeout and delivery meals
It’s easier to cut back on expenses when you’re thinking about optimizing your finances, rather than when you’re in a defensive situation—like dealing with a loss of income.
“People have gotten used to a high-growth, low-interest environment, which has resulted in lifestyle creep for many,” Zigmont says. “When you add in stimulus payments and student loan forbearance, the result is that many people are living beyond their means and need to adjust before times get hard.”
Ryan Phillips, CFP, founder of GuidePoint Financial Planning in Reston, Virginia, encourages clients not to overextend themselves during the good times.
These days especially, he urges caution for those considering big-ticket purchases like a house or car, or clients planning a home renovation project. “Given current supply chain and inventory issues, there is a risk in overpaying for some of these items,” he says. Lumber prices, for example, increased 150% during the pandemic. “When a recession ultimately strikes, these are the things we cannot go back and undo.”
4. Nurture Your Career
You may not be ready to take part in the Great Resignation and make a big career change. But even if you’re happy with your current job situation, it’s always a good idea to keep your resume updated.
If you lose your job due to a large economic event, a strong resume may make it easier to bounce back or pivot to a new career.
“Take ownership of your career,” Brown says. “Take full advantage of free courses and certifications to keep your skills updated. Refresh your LinkedIn profile so you are always job-ready.”
And while the job market is hot, it’s a good time to make sure you’re getting paid what you deserve. Research the market rate for your role and advocate for a raise if necessary.
Then, put that surplus money to work strengthening your financial safety net.