We're likely in the first recession in more than a decade, and it certainly won't be the last. If you're worried about your finances and want to make sure you're prepared for this and future recessions, there are some smart steps you can take right now to recession-proof your finances.
Specifically, here's a list of four critical things you can do that can make your finances as recession-resistant as possible, why each one is important, and some suggestions to help you put them into action.
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Build your emergency fund
By far, the most important thing you can do to protect your finances against recessions is to aggressively build up your emergency fund. If you can get to just $1,000, you'll be in better shape than the majority of Americans and will be able to cover most one-time unforeseen expenses.
However, to truly be recession-proof, you'll need an emergency fund that can cover your rent, utilities, car payments, and other financial obligations for several months. A six-month cushion is a good rule of thumb, but more or less could be appropriate for your specific circumstances. For example, if you and your spouse both work and have rather stable jobs, a three-month emergency cushion might be enough. On the other hand, if you have an unstable income stream, you may want to aim a bit higher.
The point is that any emergency fund is better than nothing. But an emergency fund that can support you if you lose your job is what you need to be truly recession-proof.
Cut unnecessary expenses (or plan to)
There are two ways to secure a recession-proof emergency fund that can financially support you for months. The first is obviously to save as much money as you can.
In addition, you can also cut certain expenses -- either now or when times get tough.
Think of it this way. Let's say you pay $50 per month for various streaming services, $50 per month for a gym membership, $20 per month for a newspaper subscription, and $20 per month for satellite radio in your car. These are expenses that could certainly be worthwhile to you, but they're all things you can live without if you had to.
Here's the point. If you're aiming for an emergency fund that could cover six months of living expenses, cutting these $140 in monthly expenses makes the amount you need to set aside $840 less. When determining the amount you'll need to save in an emergency fund, a good exercise is to make a list of all of your recurring expenses -- rent, utilities, etc. Separate them into two categories: expenses you'll have to pay no matter what, and expenses you could cut if you needed to.
Get rid of high-interest debt
When recessions hit, we often see a wave of corporate bankruptcies (we're starting to see this now). And the companies to go first are often those with high amounts of leverage, or debt, which becomes unmanageable when income drops.
The same concept applies to individuals. The more debt you have, the more likely it is you'll run into trouble in a recession. For example, if you lose your job and owe $500 per month to your creditors, it can be far tougher to stay afloat than if you didn't have this obligation. And high-interest debt such as credit card debt is the worst -- not only can these obligations eat away at your emergency fund, but much of your minimum payment will go toward interest, not paying down your principal.
In a nutshell, one of the biggest steps toward recession-proofing your finances is getting rid of excess debt such as credit card debt.
Invest with the long term in mind
Last, but certainly not least, as a Certified Financial Planner, some of the most common questions I've heard since the COVID-19 pandemic began are variations of "what should I do with my 401(k)?" and "should I sell my stocks before things get any worse?"
The short answer is that when recessions hit and markets get turbulent, the best thing to do with your long-term investment strategies is nothing at all. It's common knowledge that the central principle behind investing is to buy low and sell high, but by panic-selling in a recession, you're literally doing the exact opposite.
So, stop checking your 401(k), IRA, or stock portfolio every day. Take anything you hear from financial news outlets with a big grain of salt. If you contribute to a retirement plan, keep doing so. Smart investors keep a long-term mentality no matter what the stock market or the economy are doing, so avoiding the "noise" is an essential step in recession-proofing your finances.
