How to Prepare Financially for a Recession

Economics are cyclical; periods of prosperity follow or are followed by recession or depression. While they’re unavoidable in the grand scheme of things—and usually the economy recovers over time from any negative events—you should still understand how to prepare for them.

Dealing with a recession or depression is almost inevitable in a given lifetime. Someone who is truly financially healthy, however, will make sure they have a plan in place to handle those setbacks.

If you have prepared for a recession, you’re one of very few.

Important Things for You to Remember

Having a fully diversified portfolio can go a long way toward protecting you in case of a recession or other systematic risk. Rather than having all your financial eggs in one basket, make the effort to keep your investments across a wide variety of industries, types, and risk levels.

As you make your long-term financial plan, use an opportunity cost framework. That means measuring the options based upon the cost of giving up an opportunity, usually explained like this:

Opportunity cost = Return on the best option not chosen – Return on the option chosen

If you could invest $20,000 in the stock market, for instance, and have a specific stock in mind, but you could also use the money to purchase a certificate of deposit, you would use the opportunity cost framework to determine the best investment option. The CD may pay 1.25% APY in interest, but the stock could net you a 6% return.

Most people would choose the 6% option, but what if that company goes belly-up and you lose your investment? The cost of opportunity then would be the difference between the 1.25% from the CD and the money you lost.

Suddenly that CD may sound better, depending on your risk tolerance.

In other words, don’t choose an investment vehicle based solely on how much money you could make; also consider the risk.

If after all of your planning the economy still takes a hit, there’s no need to panic and start cashing everything out. If you’ve made a plan with the strategies below, you can just ride it out and trust your planning.

Top Strategies for Protecting Yourself From a Recession

1) Invest in Assets That Are Guaranteed to Nominally Increase in Value

When considering how to diversify your portfolio, consider investing in something that will not lose money—and may even increase slightly. Some of these include bank accounts, savings bonds, and other similar vehicles for your money.

2) Update Your Resume

You should always have an up-to-date resume just in case, but if you see a recession coming, that resume is even more important and can get you hired fast if you lose your job as a result of an economic downturn.

3) Minimize Debt

Get your debt paid off as quickly as possible, including credit cards, personal loans, and even student loans. The less debt you have if a recession hits, the fewer obligations you’ll still have to be making in the face of a job loss, salary downgrade, or other financial hit. It may mean cutting back on a hobby, maybe dining out less, or curbing other spending, but you’ll be in a much better financial position if there is a negative financial event.

4) Improve Your Credit Score

Your credit report has much to do with how many opportunities are open to you. That can become critical in a recession, when you may need to find a new job or take out a loan of some kind. Even if you find yourself needing to sell your home and move into a smaller apartment, your credit report can either help get you there or stand in your way. You can keep track of your credit score for free with smartphone apps or by getting a free copy of your report once a year to ensure there are no errors or items that need to be disputed.

5) Keep Track of Your Expenses

Budgeting isn’t just for people who are short on cash; in fact, it’s how many people who are financially secure got that way. If you’re holding yourself accountable each month for purchases that could have been avoided or done differently, you’ll be ahead of the game—and managing your money wisely.

6) Make All Risky Investments Assuming That a Recession is Coming

When you’re looking to diversify your portfolio, go into it understanding that risky investments are considered that for a reason—because the market can be fickle and recessions do come. If you go into it with your eyes open, you’ll be prepared for loss, or perhaps you’ll even make less risky choices to begin with. Risk isn’t always a bad thing as it can come with high returns. But if you know a recession is coming, you may think twice about how much of your money you’re willing to put in those investment vehicles.

7) Develop a Plan of Attack in Advance

The next recession may be a year away, or it may be ten years away. Regardless of where the economy is in its cycle, however, planning for loss or recession is always a good idea. Even if the economy itself doesn’t take a dive, you’ll be well-prepared for any financial emergency you may encounter.

Bottom Line

Recessions, downturns, and even all-out depressions can ruin a family’s financial health and cause problems far longer than the event itself lasts. Preparing now can only help you; even in the current status quo, bulletproofing your finances is a good idea. Take the time to pay down debt, check your credit rating, and put some cash aside for an emergency fund. You may not be able to predict every possible financial event, but you can prepare in a way that will set you up for success no matter what happens.