Everywhere you look in the news these days, it seems like people are talking about the same thing. The Federal Reserve has lowered rates. The stock market’s dipped. And the yield curve? It’s inverted.
Taken alone, they might mean nothing. But together? Things are starting to look a little like a recession might be coming.
The good news? In and of itself, that’s nothing to be worried about. It’s all part of the natural economic life cycle. Just as we must go through the low temperatures of winter to reach the highs of summer, so too does the economy experience some lows to grow to new heights.
The better news? A long-term, diversified investment plan already takes recessions into account, and you can take steps today to prepare for an extended economic downturn. What’s more, these are good habits to build no matter the economic season.
But first, a recap:
What’s a recession?
You might best remember a recession from your experience in 2008 to 2009, when the Dow Jones Industrial Average bottomed out at less than 50 percent of its 2007 high. But, unlike bear and bull markets, you don’t define a recession solely on market index performance.
Recessions are hard to quantify, but economists (and reporters) typically define a recession as two or more consecutive quarters of a negative growth rate of gross domestic product (GDP), or the total value of everything that the country produces. You may see the effects of a recession by decreases or stagnation in income, unemployment or less consumer spending.
How long does a recession last?
On average, a recession lasts about 11 months, according to the National Bureau of Economic Research. But they can be shorter and milder, or longer and more severe, as we know from the Great Recession of 2008 and the Great Depression of 1929. But even in extreme cases, the market itself has never zeroed out and has historically always recovered.
In the case of the Great Recession, it took about four years for the Dow Jones Industrial Average to reach a new high after bottoming out in 2009. But along the way, investments still made gains, and long-term investors who maintained regular contributions throughout the recession were best poised to reap them.
How do you prepare for a recession?
Just because you know historically all recessions have ended and led to even greater economic growth, that doesn’t make the prospect of facing one any easier. But there are a few simple steps you can take now to recession-proof your life.
1. Build up an emergency fund.
Most of us probably know we should have an emergency fund equivalent to three to six months of living expenses. But, especially when the economy’s doing well, it can be easy to shrug it off as something you’ll get around to eventually.
But when talk of a recession grows, it’s wise to turn your attention to your emergency fund. Unemployment frequently rises during recessions, and should you find yourself out of work for a few months, you’ll want to be able to tap into cash reserves.
You don’t have to start big. First, take stock of your income and spending. Make note of your bare essentials, or fixed costs. That’s probably your rent or mortgage payment, utilities, cell phone, internet, food, transportation and insurance.
Tally up your expenses for the month and then multiply that by three, four, five or six, depending on how many months’ cushion you’re aiming to give yourself.
If that number looks intimidating to begin with, don’t stress. About two in five people can’t afford to cover an unexpected expense of $400, according to the Federal Reserve.
Set a goal to reach at least a $400 fund and start small with a recurring daily, weekly or monthly deposit into your savings account. (Research tells us it’s much easier for us to build savings when we automate it.) You can build up a fund of $400 in about five months with a weekly $20 deposit.
From there, continue and increase your contribution until you’ve reached at least three to six months of expenses.
Bonus: To help protect your money from inflation (the amount the cost of goods and services increase), find high-yield savings accounts to stash your emergency fund in. These accounts can offer interest rates almost 20 times higher than the national average of .09 percent, better helping your money maintain value over the long term.
2. Check your spending.
As you’re adding up your expenses to determine what your emergency fund should be, take a moment to look at your overall spending. If you don’t already follow a budget, now might be a good time to start.
Most experts recommend a general framework of 50/30/20 budget, where half of your income goes to necessities, 30 percent to wants and 20 percent to savings, investing and paying off debt. If you haven’t worked with a budget before, a 50/30/20 approach may be a good place to start. Other popular budgeting techniques include envelope budgeting, zero-based budgeting and pay-yourself-first budgeting. The method you choose, though, is less important than making sure your total spending adds up to less than your income for a month and that you’re setting aside a healthy portion for retirement.
When you look at your spending, look for easy areas to slash, starting with mindless spending. This can be anything from impulse purchases to recurring subscriptions you don’t use.
After you’ve cut more flexible spending costs, you may want to turn to minimizing your more fixed costs. This could mean finding an apartment farther from the city center, moving in with roommates when your lease is up or looking into cheaper forms of public transit instead of owning or leasing a car.
3. Get ahead of any debt.
If you have any debt, now is the time to put repayment plans into place. Should you find yourself with less income during a recession, you want to make sure you’ve minimized or repaid what you owe so your debts don’t mount during a downturn. First, list out all of your debts, making sure to note the amount you owe and the interest rate associated with it.
Then consider one of these popular payment methods:
Snowball method: In the snowball method, you start small, by targeting the smallest value debts first. While you may end up paying slightly more over the long term by prioritizing based on amount, rather than interest rate, some people find it more rewarding to rack up a lot of small wins before targeting larger loans.
Avalanche method: In the avalanche method, you zero in on your highest interest debt, like what you owe on credit cards, and clear it before moving on to your next highest interest loan. Though you may end up chipping away at larger numbers for longer in the beginning, over time, you may save a little more money than if you targeted based on loan amount.
4. Maintain your regular investments.
It can seem counterintuitive, but during a recession, you probably don’t want to stop your regular contributions to your investment accounts, whether that’s your 401(k), Individual Retirement Account (IRA) or a taxable brokerage account.
While it can be stressful to put money into a downward-trending market, it allows long-term investors to benefit from what are essentially sale prices on investments. Over years, this can allow you to scoop up shares at fractions of their later values and help you pay less per share overall, thanks to dollar-cost averaging.
Take this example: You start investing $50 a month in an S&P 500 fund in March 2006, two years before the bottom of the Great Recession. If you left your money untouched and continued regular $50 contributions, you’d have more than $12,000 by March 2018, assuming you reinvested your dividends. That’s a growth of about 70 percent, or $5,000, over the base amount you invested.
You might think you could game the system by taking your money out of the market at its high and then reinvesting it when it hits its bottom. But timing the market is notoriously hard to do and can drastically curtail your earnings if you miss days when the market makes large gains.
During a recent 20-year stretch, investors who took their money out of the market and missed the top 10 days of trading would have seen their returns fall by almost half, to 4.5 percent, according to one Schwab analysis.
Those who kept their money invested, on the other hand, saw average annual gains of about 8 percent.
It’s almost impossible to time the market, but by maintaining regular contributions to your investment accounts, you poise yourself best to benefit from any future upswings.
5. Refine and diversify your skill set.
Unemployment frequently rises during a recession, as businesses look to cut costs and consumers spend less. This can lead to a vicious cycle of companies laying off workers who then have less money to spend, forcing more companies to downsize (and then more workers to be let go).
But a rising unemployment rate doesn’t mean that all companies stop hiring or even stop expanding.
To best position yourself to keep your current job, look for opportunities now to take on new responsibilities at work. During an upward-trending market, this can position you for raises or promotions, but as things become bleaker, it can make you indispensable at the office.
Outside of your full-time job, search for ways to diversify your income stream, whether that’s through side hustles or volunteer work that allows you to learn new skills you can later use to earn money.
The bottom line
While no one can predict when the next recession will start (or once it’s started, when it will end), you can position yourself now to avoid a lot of its brunt. Markets rise and fall. Jobs come and go. But historically, every downturn has ended in an upturn, and good financial habits established now will help you weather any kind of market better.
Investing involves risk including loss of principal. This article contains the current opinions of the author, but not necessarily those of Acorns. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.