Despite inflation easing a bit in October, many economists and indicators are predicting a recession at some point in 2023, even if there is a possibility that it will be a “soft landing.” Continued Fed interest rate hikes and a slowdown in hiring are also contributing factors to these predictions.
Even if a recession isn’t guaranteed, it’s all over the media. And it is causing plenty of fear. Well, one of the best ways to combat fear is to prepare for what MIGHT happen as much as you personally need.
So I’m here to do two things for you today. First, we’re going to define a recession. Then, I’m going to give you seven things you can do now to prepare for a possible recession—none of which are extreme.
And this is for every downturn. Whether we have one next year, the year after, or five years down the road, you’ll be able to use these tips to keep yourself prepared for a possible recession so you can live life how you want without fear.
Let’s dive in!
What is a recession?
Recessions (just like a lot of things) are sensationalized in the mainstream media. They instill fear, division, and panic. I’m going to give you a tip.
The problem with a recession is that there are a few different definitions. For example, one definition you’ll hear often is that a recession is marked by two consecutive quarters of negative GDP (gross domestic product) growth. By that definition, we entered into a recession after the first two quarters of 2022 had negative growth.
Another definition is given by what’s called the Sahm rule, named after economist Claudia Sahm. The Sahm Rule says we’re at the start of a recession if the three-month moving average of the national unemployment rate rises by 0.5% or more relative to its low point during the previous 12 months.
The U.S. unemployment rate has been hovering around three and a half percent since March 2022, so the Sahm Rule says we are not in a recession.
Generally speaking, the definition we want to go with is the National Bureau of Economic Research (NBER). They define a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
The average length of a recession
NBER tracks the timeline of all recessions since the 1850s. Since the end of World War II about 75 years ago, the average recession has lasted about 10 months.
Whenever we think of a recession, our minds automatically go to the Great Recession of the late 2000s. That recession only actually lasted 18 months before we started on a growth track again. However, it feels longer because the S&P 500 didn’t recover to pre-great-recession levels until March 2013 after hitting the floor in March 2009.
The fear comes from the uncertainty about how long it’s going to take for the economy to recover. The S&P took 4 years to recover after the Great Recession while unemployment took about 9 years to recover. The Great Recession was far from the normal recession though—hence its special name.
7 things you can do to prepare for a recession
In reality, recessions are natural contractions in the economic cycle. Lots of things can cause them. Do they adversely affect people? Of course it does. But if you prepare correctly, you’ll have nothing to fear even if we do end up in a recession.
Here are seven things you can start right now to prepare for a recession.
1. Increase your emergency fund
I believe an emergency fund should be personalized. Blanket statements like “save 12 months of expenses” can be effective. But you’ll miss out on opportunities to invest that money and stare at the balance wondering why you have so much money sitting there.
The most important piece of the emergency fund puzzle is how much money you personally need to feel comfortable. To get a baseline for how much emergency fund you personally need, ask yourself these three questions:
- How much extra money do you already have per month? If you’re already living close to paycheck-to-paycheck, you’ll more than likely want a larger emergency fund. If your monthly cash flow is high, you may not need as much because you can weather a lot of emergencies even without your emergency fund.
- What is the likelihood of you having a financial hardship? Consider how secure your job is, how young you are, how healthy you are, if someone is going to propose to you and you might need to channel money to a wedding, etc. Health and kids are two more things to consider. This may change with a possible, even likely recession.
- What’s the smallest emergency fund you’d feel comfortable having? Again, this is the magic question. How comfortable are you with the amount you have to take on a financial emergency? It’s ok to stash more than you need if it makes you feel financially secure. This may also change with a possible upcoming recession.
Now that you have a baseline, how much do you need to increase that given a possible recession? Is your otherwise secure job less secure in a recessional environment? Is there a greater chance of being unemployed?
How much would you feel comfortable with?
Personally, I’m working to increase my emergency fund by $2,000 – $5,000. Overall, my income is secure but this is what I feel comfortable doing. Once I get to $2,000 over my normal emergency fund, I’ll see if I need to go higher.
2. Budget the right way for you
Recession or not, this will always be the best way to manage your money. You have to budget in a way that works for you.
The best place to set up your perfect budget is in my book, The Root Budgeting System. Most personal finance authors give you their method for budgeting, but The Root Budgeting System shows you how to create your own budgeting system that will work for you and not against you.
It makes it natural for you to budget—and easy to stick with—by focusing on five key steps. Here’s how you can create a budget that is right for you:
- Start with the basics. Gather your income and expenses and see how much cash flow you have right now. This is where every budget needs to start.
- Learn the Three Pillars. The three pillars, or must-haves, that every budget needs are automation, tracking your spending, and an emergency fund. After this step, you start making your budget your own instead of someone else’s.
- Find and incorporate your values. This is your show. Identify what you value and implement those values into your budget. For example, if you value dining experiences, find a way to incorporate that into your budget and allow yourself to spend money on it guilt-free.
- Choose budgeting principles that make sense for you. Give every dollar a job…but only if you want to (I don’t). If a particular budgeting principle doesn’t work for you, don’t use it. Simple as that.
- Set up a Frequency Budget. This can also be called a “mini-budget.” Within your personal Root Budgeting system, you can break your budget down into smaller, paycheck-sized frequencies so you know exactly where the money for your bills will come from. It’s like breaking down a large goal into more manageable milestones to make it easier to reach.
As you look at what your budget may need to look like in a recession, start with cutting out things that are not of value to you. Dig deep into if it’s something you value to you or not.
It’s important to be honest with yourself in this process because cutting out the things you don’t value leaves more money to spend on the things you do.
And in a potential recession, you still want to be able to spend money on things that matter to you.
No matter what, remember any potential cuts you have to make due to a recession will be temporary.
3. Pay down debt (if you can)
Unnecessary debt is one of the biggest roadblocks to true financial freedom in even the best of economic times. Notice I did not say “bad” debt.
I don’t like the monikers “good debt” or “bad debt.” They paint a picture of debt that is only black and white. But when you dig deep, it’s more gray than anything.
Think about it, your “good debt” may turn bad in a recession. And thanks to the media, we all know how the “good debt” of a formal education turned bad for many people. (I’m not against college. It’s just not the good debt people think it is.)
I prefer the terms unnecessary debt and necessary debt. A mortgage may not be “good debt” when you factor in all the phantom costs of homeownership, but it is necessary debt since most people are not able to pay cash for their homes.
In preparation for a recession, it’s best to pay down almost any kind of debt you may have.
Make it realistic. Don’t focus on your mortgage if you have a bunch of credit card debt. In fact, if your current mortgage interest rate is low, it’s safe to ignore that and focus on other things like paying off credit card debt and saving for emergencies.
Here’s a seven-step process to set up your own debt payoff plan:
- Figure out how much total debt you have. This is always the first step. You won’t know how to plan unless you know exactly how much you have to pay off.
- Decide how much money you have to put toward debt. Your budget is key for figuring this out.
- Choose your debt payoff strategy. The debt snowball, debt avalanche, or highest monthly impact are the main three.
- Snowball your payments. Pay off your debt faster by adding the previous payment to the next one regardless of your debt payoff strategy.
- Set up a reward system. Use rewards to keep you motivated and pat yourself on the back.
- Consider if you want to sacrifice anything to pay off the debt sooner. This will depend on what it is and how much you can sacrifice and will look different for everyone. Sacrificing something you value that is only $20 a month won’t do much overall, so it probably isn’t necessary. But you’d also be surprised at how much of an effect even a little extra money has on your debt payoff plan.
- Automate the entire plan. Don’t rely on your motivation or memory. Automate payments to set your plan on autopilot.
For an in-depth plan check out my ultimate guide. That post also goes into more detail on the difference between necessary and unnecessary debt.
I’m also here as a coach if you need more personalized help.
4. Diversify your investments and ride it out
In a recession, the stock market decreases in value. That means any stock you own may go down in value. It also means any stocks you buy are effectively on sale.
That means the best way to ride out an economic downturn in the stock market is by diversifying and riding it out.
Continue to invest in low-cost index funds that follow the entire market so you are purchasing a small portion of many companies at a discount during the recession. This is the best form of diversification.
Then, when the markets bounce back you’ll be set to make a nice return on your investments.
Dollar cost averaging, or the practice of investing the same amount of money on a consistent basis, is the best way to do this.
It’s like a 401K plan with an employer. You’re investing a specific amount like 5% or 10% at a specific frequency (i.e. every time you get paid).
And if you get an employer match on your 401K, you’ll definitely want to continue investing.
In essence, during a recession, you’re doing what you should always be doing.
5. Consider starting a side hustle for an extra income stream
This one is pretty simple. Just like with your investments, diversifying your income creates not only brings in more money but lessens the effect of losing an income during a recession.
This doesn’t have to be anything over-the-top. This could simply look like:
- Getting a part-time job in the evenings or weekends
- Using your love of writing to write content for companies or agencies
- Setting up a life coaching business on the side
- Creating and selling music
- Starting a resume writing service
- Designing websites for small businesses
The possibilities are endless. Start with a hobby and see if you can monetize that. Keep in mind that some of these may take some work to get off the ground. I’m not going to pretend any of it is easy. But now is the time to start.
Who knows, you may end up with a business that can support you full-time in the future.
6. Create an emergency budget
An emergency budget is a budget you create simply for emergency purposes.
Essentially, you are planning now for any potential emergency in the future such as a job loss or other significant event that may change your financial outlook.
The purpose of an emergency budget is to be able to switch to this new budget in a flash so you don’t have to worry about planning while you’re in the throes of financial chaos.
To create an emergency budget:
- Create a duplicate of your current budget and label it “Emergency Budget”
- Highlight all absolutely necessary expenses (Food, shelter, transportation, etc.)
- Remove anything ext
If/when the time comes for you to use your emergency budget, you can just pull this out and start using it. Then, depending on how long the emergency is, you can add in a few things you value.
Again, it’s important to remember any emergency situation like this where you may have to make drastic cuts is temporary. Nobody wants you to live like this forever.
7. Focus on increasing your skills
One of the main concerns in a recession is the contraction of the labor market. People fear losing their jobs and not being able to find work for a long time.
While that can be a valid concern, you can mitigate any length of time you’re unemployed by increasing your skills
Research some in-demand skills in your field and learn about them. Take courses and practice. Learn from mentorships and be open to feedback as you develop. Certifications are a great indicator of skill level as well as experience—and they look great on a résumé.
Increasing your skills also has the pleasant effect of increasing your earning potential overall, recession or not. If you develop in-demand skills in your field, there’s a good chance you’ll be able to find better pay. There’s no downside.
Recessions can be scary, especially when the media overhypes it—just like they do everything else.
But don’t panic.
In fact, that’s one of the biggest tips I can give you. Don’t. Panic.
You’ll be fine. You have what it takes to make it through any economic downturn. And these seven tips will help you prepare so you can sleep soundly and have some peace of mind.
And what happens if we don’t have a recession or it doesn’t affect you? The nice thing is doing any of these seven things will only help your financial situation whether we’re in a recession or not.
It’s a win-win.