3 Steps You Can Take to Financially Prepare for a Recession
A recession is coming, but no one knows when.
tl;dr: prepare for a recession by topping off your e-fund, penciling out your barebones budget, and embracing investment volatility.
A recession is coming, but no one knows when.
Whether we like it or not, a recession is coming. It could be next month, next year, next five years—nobody knows. But most people agree that it’s coming. So, rather than panic, let’s simply focus on what you can control.
Here are 3 steps you can take to financially prepare for a recession.
Top off your emergency fund.
Your emergency fund is the moat around your financial castle.
It’s what stands between you and life's inevitable ups and downs. Most financial professionals recommend keeping 3 to 6 months' worth of living expenses saved in your emergency fund. 6 months is the default recommendation, while 3 months may be an okay fit under certain situations like a dual-income household or someone with a recession-proof job.
During a recession, cash is like oxygen—if you don’t have it, it’s the only thing that matters.
To prepare yourself for a recession, calculate how much you should have in your emergency fund based on your living expenses. Start with a minimum of 6 months, and adjust up or down as needed. Then, compare that to where you are currently—the gap is where you should focus. If your emergency fund is light, that may need to be your top financial priority as you prepare for a recession.
Remember, emergency funds need to be accessible during a pinch, so focus on easy access and zero risk for your e-fund.
tl;dr: top off your emergency fund using 6 months of living expenses as a starting point.
Know your barebones budget.
There’s your normal budget, and then there’s your barebones budget.
Whether you need to use it or not, it can be a helpful pre-recession exercise to figure out your barebones budget. As the name implies, your barebones budget is what you would need each month to sustain your bare necessities if you tightened your purse strings. The details will vary by person but imagine you were to cut everything out of your budget that is not necessary to survive.
What would that look like?
A great way to think about your barebones budget is using Dave Ramsey’s four walls analogy. Ramsey says that when you’re trying to cut back, focus all of your energy on maintaining your four walls:
Food
Shelter
Basic clothing
Basic transportation
Those four walls make up your barebones budget.
By figuring out your barebones budget, you should feel confident knowing exactly how much money you need to maintain your four walls during a recession. Whether you use it or not, this can give you the peace of mind you deserve when navigating difficult economic circumstances.
A bonus to the barebones budget is that it can help extend your emergency fund.
For example, if your 6-month emergency fund is based on your standard budget of $4k per month, but your barebones budget is just 2.3k per month, your 6-month emergency fund could sustain you for over 10 months.
tl;dr: figure out your barebones budget by focusing on the four walls: food, shelter, basic clothing, and basic transportation.
Make peace with investment volatility.
One of the biggest mistakes investors make during a recession is selling their investments.
Of course, situations vary, but as a rule of thumb, you do not want to be selling your investments during a recession. If you sell, you lock in losses. But if you hold, you still own the same number of shares you had before the downturn. Unfortunately, many investors panic when the market takes a turn for the worst, selling their investments as they retreat to the sidelines, locking in steep losses. Please don’t let that be you.
If you’re a long-term investor, make your peace with investment volatility now.
Understand that volatility is the fee you pay for great investment returns—it’s not a fine or penalty you should try and avoid. Markets go up, and markets go down—it is the way. That doesn’t mean it’s not painful, but it does mean that it’s all part of the process. So do your best to shift your mindset by remembering that when the market is down, it’s an opportunity to buy stocks at a discount.
And as a bonus—if you’re able to hold on, continuing to dollar-cost-average into the market during a downturn, you could be rewarded handsomely when things bounce back.
tl;dr: make peace with investment volatility to avoid panic-selling during a recession—do your best to continue buying during a downturn if you’re a long-term investor.
In the end, remember that recessions are a normal part of our economic cycle in the US. Markets go up, and markets go down.
And although nobody knows exactly when the next recession will come, you can use the 3 simple steps outlined in this article to remain confident and secure in your financial situation, no matter which way the economy is headed.