The term recession is one which, understandably, invokes fear in a lot of people. However, whilst there is not much we ordinary citizens can do in order to prevent a recession, there are steps we can take to help prepare ourselves for one. Keep reading to find out how to prepare for a recession.
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What Is a Recession?
A recession is a decline in economic activity, typically defined by two consecutive quarters of negative economic growth.
Whilst this is undoubtedly an undesirable situation for an economy to be in, it is important to bear in mind that it is an unavoidable part of the economic cycle. Periods of economic expansion don’t last forever and are inevitably followed by a period of contraction sooner or later.
As an economy contracts, consumer spending tends to fall and unemployment can increase as businesses lay-off staff to compensate for falling revenue. It goes without saying then, that this can be a stressful time. So, what can you do about it?
How to Prepare for a Recession
There is nothing that individual consumers can do to stop a recession from happening, but we can put ourselves in as strong a position as possible to weather the storm. Here are some ways in which you can prepare yourself.
Re-evaluate Your Expenditure
When times look like they might get tough, it’s always a good idea to sit down and reassess where your money is going each month.
Make sure that all your income is accounted for and that all your expenditure has a purpose. Cut back on frivolous or unnecessary expenses and see if, by doing so, you can free up additional cash. But what should you do with this surplus income?
Build an Emergency Fund
Building a healthy emergency fund of easily accessible cash should be your first priority. In fact, recession aside, if possible, it’s arguably always important to have cash on hand to protect yourself from any unexpected scenarios.
If you have already gone through your expenses, then you should have an idea of how much money you need each month to survive, build your savings with this figure in mind, making sure you have enough to sustain yourself if you have to contend with a period of unemployment.
Whilst there is no set rule for how much you should save, a good starting point is to try and accumulate enough money to cover three to six months’ worth of expenses.
Reduce High-Interest Debt
If you already have an emergency fund in place, your next port of call might be to pay down any high-interest debt.
If you have a lot of outstanding credit, that means more monthly expenses to worry about if you lose your income and, if that debt is accumulating a high level of interest, the longer you take to pay it back, the more money you’ll end up paying.
Clearing down existing debt levels can also help improve your credit score, which could prove useful in case you reach a point where you need to turn to borrowing to support yourself.
Keep Investing
If you’re already investing regularly in the markets, stay the course and continue to do so for as long as it is feasible. If you’re not already investing regularly, then you might want to consider starting to do so.
A long-term investment plan should already account for the possibility of recessions and, therefore, you shouldn’t let the threat of a downturn stop you achieving your financial goals.
Getting into the routine of investing every month is important for your long-term financial security and also provides you with a diversified range of assets you can turn to if your emergency fund dries up.
What Not to Do
An economic downturn is always a stressful time to live through - but try not to panic. As we noted earlier, recessions are a normal, albeit unwelcome, part of the economic cycle.
A recession will undoubtedly have a knock-on, negative impact on the financial markets, as uncertainty and fear spread amongst market participants. For investors, it will naturally be disconcerting to see the value of your portfolio suddenly plummet, but try to remain rational.
Just because everybody else is panicking and selling their assets, it doesn’t necessarily mean that you should as well. Remain objective and don’t allow emotion to cloud your judgement.
Liquidating assets or changing investment strategy during a market downturn are not decisions to take lightly. Trying to time the market by rotating your assets into more defensive industries or liquidating them entirely is risky and difficult to successfully pull off.
Final Thought - Be Greedy When Others Are Fearful..
Arguably the most successful investor of all time, Warren Buffett, once said that investors should be “fearful when others are greedy, and greedy when others are fearful”, and it is with this thought that we will end our article.
If you are truly confident about the long-term success of a company, or another investment, then you shouldn’t necessarily overconcern yourself with short-term movements in its price.
During a recession, it is likely the stock market will drop as many people tend to panic and sell their shareholdings. This means that, if investors are able to save additional cash on top of their emergency fund, a stock market slump can sometimes provide an opportunity to pick up shares in quality companies for a lower price.
There have been 15 recessions in the US since the start of the 20th century, and, whilst the stock market has always been negatively impacted in the short-term, it has always recovered and continued to grow. Of course, past performance is not a reliable indicator of future results, and there is no guarantee that this will always be the case.
Furthermore, those considering investing during a recession will need to be prepared to be patient. It could take a long time for the stock market to fully recover. Therefore, you should only invest money which you could afford to live without. This statement is always true, but it takes on increased significance during a market downturn.
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