Nobody likes the R-word. Recessions, or periods when the economy is shrinking instead of growing, can hurt the stock market and have real-life consequences, including layoffs.
However, recessions happen frequently throughout history. Since World War II, the United States economy has averaged a recession every six and a half years.
Your wealth-building journey will likely span decades, putting you on a likely collision course with eventual adversity. While you can't prevent recessions, here is how to prepare for them.
1. Treat your household finances like a business
Investing is vital to building wealth, but you must have a healthy foundation for your household finances before considering the stock market. Consumer spending is the heartbeat of the American economy. The constant blitz of advertising and friends and relatives upgrading their lifestyles can easily tempt you into splurging on extravagant purchases.
Treating yourself is great, but do it responsibly. Consider treating your finances like a business -- question major purchases to determine whether they're worth shelling out for and what return you expect.
Most importantly, avoid taking on too much debt.
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Many people are seeing the ugly impact of America's recent transition to higher interest rates, which makes things like car loans, mortgages, and credit cards more expensive as interest rates soar. A common rule is to avoid paying more than 36% of your gross monthly income toward any debts, including your mortgage. You want to avoid being susceptible to layoffs or other unpredictable challenges a recession can create.
2. Put money into an emergency fund
If your debts are manageable, consider putting money into an emergency fund. That's an amount of money placed aside that's easily accessible and dedicated to unexpected problems. That could be a major car repair or the heat failing in January. An emergency fund is not for paying for your hot date this weekend.
An emergency fund helps protect you from getting pinched by an unexpected bill, forcing you to put it on a credit card or take a payday loan. These high-rate loans are traps that infamously snare borrowers in payments.
Ultimately, you want your emergency fund to be at least large enough to cover these random unfortunate events -- say one or two thousand dollars for a starting point. If you're more financially established, a few months' living expenses is a great goal.
3. Keep investing
Recessions don't have to be only about survival. They also tend to generate significant investment opportunities. The stock market can fall from recessions (or fears of a potential recession). You can see below that the S&P 500, an index of 500 of America's largest corporations, has fallen 20%, or 40% or more from its highs, numerous times.
The downturns aren't fun, but they can be lucrative if you continue investing through the volatility. The broader stock market has historically rebounded from every bear market, and while that's no guarantee it always will, it's solid evidence that you can be optimistic.
You can maximize your odds of success by sticking to blue-chip stocks and index funds as part of a diversified portfolio, avoiding the riskier stocks in bad businesses that might not survive to see the next economic upswing. A responsible investment strategy used with the above-mentioned financial foundation can turn a recession into an opportunity.
