Confused About Recessions? Read This 3-Minute Guide

Everything you need to know about recessions in just a few minutes.

Business leaders and economists have been sounding the warning bell about an economic downturn for several months. So, what's the big deal? What exactly is a recession? And how can you prepare? Find out with our three-minute guide. 

What is a recession?

The most common way to define a recession is as a prolonged period of economic decline. Recessions can be painful, but they are a normal part of economic cycles. In good times, the economy grows. But in bad times, the economy shrinks. 

Some say that if the economy shrinks for two straight quarters, the country's officially in a recession. The reality is a bit more complicated. There's an organization called the National Bureau of Economic Research (NBER) that defines when a recession begins and ends, and it uses a few different indicators to make that call. 

How long do recessions usually last?

Recessions can take different shapes depending on what's caused them and how they are handled. Looking at recessions since 1854, the NBER puts the average length at around 17 months. The shortest recession on record was the COVID-19 recession of 2020, which lasted just two months. 

How might a recession impact me?

One of the biggest impacts of a recession is that people can lose their jobs. When faced with decreased demand, businesses look to cut costs. One way they do this is to first cut back on plans for new hires and then lay off existing employees. Economic downturns can lead to increased unemployment and reduced job security all round. 

Another impact is that the value of your investments may fall. We've already seen a bear market in 2022, and some experts predict the stock market's performance could worsen in 2023. There's a lot of uncertainty about what might happen. But this type of volatility can have a big impact on people nearing retirement age and looking to withdraw from their portfolios.

What can I do to prepare?

The first step you can take to prepare for a recession is to understand your financial situation. Look at how much cash you have in your bank account, what your monthly outgoings are, and how much money you owe. If you aren't sure where to start in terms of tracking your spending, a budgeting app might help. 

Once you know where you stand financially, turn your attention to your emergency fund. Having three to six months' worth of living expenses socked away in a savings account can make a big difference in the event of a financial emergency such as a job loss. 

If you carry high-interest debt, particularly that of the credit card variety, look for ways you can pay it down. If you lose your job or your income gets cut, any debt repayments will eat into your monthly costs. Plus, if you fall behind on your payments, you may have to pay late fees, your credit score could take a hit, and you may eventually have to deal with debt collectors. The more you can pay down before an economic downturn, the better.

Bottom line

Recessions are not fun, but they do pass eventually. We don't know whether we'll enter a recession in 2023, and if we do, how severe any downturn might be. The best way to prepare is to strengthen your financial foundations. If we do hit a recession, you'll be better able to weather the storm. If we don't, you'll be well positioned to handle any other financial emergencies that arise.