What Is a Recession and How Do You Prepare for One? A recession might be looming, but you can prepare for it. Discover what happens in an economic downturn and how to prepare for one in this detailed guide.
By Dan Bova
The news is abuzz with rumors of the next recession coming in 2023 or 2024. But for most Americans, all of that triggers a sudden panic and a desperate need to look at one's bank account.
What is a recession, what does it mean, and how can you prepare yourself and your family's finances for one? This article will answer each of these questions and more. By the end, you'll know what to expect and how to prepare for a recession.
What is a recession?
According to economists working for the National Bureau of Economic Research, a recession is a prolonged period of economic downturn or declining economic activity.
It affects a nation's or the world's entire economy and lasts for a few months or more. In some ways, the best way to understand the recession is to compare it to "regular" or positive economic activity and GDP.
GDP (gross domestic product) is essentially the combined value of the goods and services made by an economy, like the American economy. The country's GDP grows a bit each day/week/month in a standard economy.
When a recession kicks in, there is no economic expansion. Instead, the GDP is negative — the value of goods and services in the economy decreases — for more than two quarters or approximately six months. People stop spending as much money when this happens because the dollar's value decreases.
Related: Are We in a Recession? Here's What Economists Say
This decrease in consumer demand triggers a decline in industrial production, exacerbating the spiral effect and making a recession last longer. A significant decline in the business cycle, characterized by many consecutive quarters of lower consumer spending, may lead to job losses or a high unemployment rate.
Several past recessions have stalled economic growth and led to the depletion of the Federal Reserve or the "Fed."
These include the recession leading into World War II, the Great Recession financial crisis, which occurred in 2008 from speculation on real estate, and the most recent recession brought on by the Covid-19 pandemic and the necessary cutback/slowdown on retail sales in the U.S. economy.
Signs of a recession
Aside from this recession indicator, some typical economic indicators also have other signs and symptoms to pay attention to.
These signs include:
- More layoffs than average, a tighter labor market.
- A general, widespread decline in stock market stock prices.
- More businesses are going bankrupt than usual.
- Fewer raises or promotions for workers.
Related: Are We Headed for a Recession? It's Complicated.
As for GDP? According to some sources, the American GDP was -1.6% in the first quarter of 2022 and -0.9% in the second quarter of 2022. Technically, this means there is currently a recession, regardless of what people say.
Note that a recession differs from a depression, which is much more severe. In a depression, the economy tanks significantly, and many more people may lose their jobs and money.
In contrast, a recession is usually relatively short-lived. Some people may not feel a recession's impact, depending on how much money they have saved up and their financial situation before the recession occurs.
In any case, a recession is never good news, which could signify that you must prepare accordingly.
How to prepare for a recession
Fortunately, there are multiple ways in which you can prepare for a recession. Good recession prep can keep your finances secure until the recession recedes, allowing you to maintain your investments, keep your savings account intact and provide your family with peace of mind.
Knock out as much debt as possible (and avoid new debt)
Your priority should be to get rid of as much debt in your name as possible. You should already be trying to clear debt aggressively. The longer you leave it hanging around, the worse your credit will be and the more interest fees you'll pay over time — it's lost funds.
As you put more of your money toward knocking out your debt, prioritize high-interest debt, such as credit cards and loans with high-interest rates. When you get rid of as much debt as possible, you set yourself up for financial success during the potentially turbulent economic times ahead.
Avoid taking out any unnecessary loans or opening up new credit accounts during this timeframe. If you avoid further debt, you'll have more money to spend on savings or necessities, which may be necessary soon.
Related: How to Recession-Proof Your Business
Keep saving aggressively
Speaking of saving, you should continue to save aggressively or even save more money than you were previously.
You might not get an unexpected promotion or pay raise during the recession. Even worse, your job could be at risk if you recently joined a company or are at the beginning of your professional career.
In these cases and others, your income streams could dry up unexpectedly. If you save aggressively before that happens, you'll be well-positioned to get back on your feet and weather this economic storm until clear skies return.
Try to save as aggressively as possible and put that money into a secure savings account. That way, you'll earn interest on those savings and avoid accidentally spending the money.
Diversify investments
Plunging numbers and red lines on charts are not reasons to withdraw all of your investments or blow up your portfolio if you're invested in the stock market. You should keep your money in the market; after all, the stock market will eventually rebound just like it always does.
Instead of panicking, diversify your investments by distributing your money into different stocks, funds, and other securities and assets. When you diversify your portfolio further, you protect it from economic damage, even from recessions.
Plus, if you diversify your investments instead of withdrawing from the market, you'll prevent yourself from losing money in the short term.
Every time a recession occurs, some Americans invested in the market sell all of their securities, which only lowers prices for those securities. Then they regret this panicked decision as the market inevitably rebounds, with many stocks achieving higher prices than they reached previously.
Bottom line: keep your investments in the market and keep your eye on the prize, particularly for long-term gains. A recession will eventually pass. Your current positions may be unattainable the next time you have money to invest in the market.
Related: Worried About a Recession? Do This to Prepare Your Company.
Bump up your credit
Your credit score is also essential during a recession. You should improve your credit score before and during a recession whenever possible, primarily by eliminating high-interest debt such as credit card debt.
If necessary, move any high-interest debt to a new credit card with an introductory 0% APR offer for any balance transfer funds. This can be an excellent way to quickly pay down any other debt in your name (in keeping with the tip above) without paying extra interest.
In any case, try to improve your credit so you can take out emergency loans if necessary, and so any other fees or financial strain you face over the next few months, reduce your credit by as little as possible. Many people feel the aftereffects of recessions for years to come, primarily because it damages their savings accounts or credit scores.
Don't panic
Do not panic if and when a recession occurs or when the news anchors start talking about it. Contrary to what some may believe, recessions are standard parts of the economic cycles inherent in capitalism.
Simply put, recessions are inevitable declines in economic activity that eventually fade away. Once people stop panicking about the effects of a recession, economic activity should return to normal, and businesses will start to boom again.
Just thinking of a recession in this light — a regular element of the economy and not something to necessarily be feared — will help you keep your head straight as you plan.
Not panicking is crucial, so you keep spending and saving money, which are essential actions to do your part to prevent the economy from spiraling downward even further.
Summary
Recessions might be financially uncomfortable, but they are far from devastating if you take the right steps beforehand. The proper prep and patience will go a long way toward shoring up your bank accounts and protecting your finances throughout the upcoming recession until the market upswings again.
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