What does it mean to be in a recession? 10 ways to financially prepare

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You may have heard rumblings of a coming recession, and it’s understandable that just hearing the word alone may cause a degree of anxiety, especially when it comes to your finances. 

Given that most of us have already lived through several recessions, including the most recent one spurred by the COVID-19 pandemic, it’s natural to wonder what we should all be doing in advance to prepare for the next one.

A recession can be a challenging time for both individuals and businesses. However, it’s possible to navigate any economic downturn more effectively by understanding its root causes and taking the necessary steps to proactively protect your finances.

Here, we’ll discuss why recessions happen and how you can prepare to weather the storm if a recession occurs.

What is a recession?

A recession is a significant decline in economic activity that’s generally marked by a decrease in gross domestic product (GDP) over two successive fiscal quarters. While some recessions last for months, others can last for several years.

During a recession, there is usually an impact across large areas of the economy, including a decline in industrial production, consumer sales, and spending, as well as a rise in business closures and unemployment. This can lead to significant economic difficulties, such as low growth, high inflation, and rising federal debt.

For individuals, especially those who face the loss of a job, a recession can cause personal financial struggles and economic hardship.

What are some common causes of a recession?

Although the pandemic-era recession was somewhat of an outlier in terms of root cause, recessions generally happen for a variety of common reasons, including the following.

• A financial crisis:

   

  This can result from a credit crisis, a sudden drop in stock prices, or widespread decline in home values.

• A decline in consumer or business spending:

   

  This may be due to a period of economic uncertainty, a decrease in consumer and business confidence, and high unemployment rates.

• A sharp decline in exports:

   

  This may occur when international economic conditions sharply reduce demand for a country’s goods and services.

What are some strategies to mitigate the impact of a recession?

Governments and businesses generally take certain measures to mitigate the impact of a recession, including the following.

• Monetary Policies:

   

  Central banks may use monetary policies, such as lowering interest rates, to help stimulate economic growth.

• Fiscal Policies:

   

  Governments can also introduce tax incentives and investment in infrastructure projects to help boost or encourage spending by both consumers and businesses.

• Innovation:

   

  Businesses may attempt to overcome the challenges of a recession by introducing innovation in the form of remote work policies, market automation, and digitalization.

How to financially prepare for a recession

Although it’s always essential to manage your finances responsibly, it’s especially important to do so both leading up to and during a recession to help mitigate the personal financial impact of an economic downturn that’s out of your control. Here are some ways you can financially prepare for a recession.

1. Keep an eye on the economy

Pay attention to economic indicators, such as GDP, inflation, and unemployment, as these may provide valuable clues on the state of the economy before it shifts downward. Being in the know about what’s going on in the larger economic picture may help you better prepare for its impact on you.

2. Build savings

One of the most important things you can do to protect yourself from a recession is to build your savings so that you have a financial cushion during tough economic times. Whether it’s because of a global downturn or something more personal like the loss of your job, having a nest egg can offer some protection from unexpected expenses or emergencies in any financial crisis. Aim to have at least 3-6 months' worth of living expenses saved in a high-yield savings account.

Need some help reaching your savings goals faster? A high-yield Varo Savings Account offers no fees and easy auto-saving tools to help grow your money.

3. Maintain a budget

Budgeting your money carefully to maximize your financial resources can also be essential both before and during a recession. The main point of a budget is to track your money so that you can rest assured that you have the important stuff covered before spending on anything that’s not essential. This is all the more vital if you have less money coming in during a financial downturn and have to prioritize your spending more rigidly.

4. Pay down high-interest debt

While paying off debt is already a challenge for many of us, it can be even more difficult if you are facing financial hardship during a recession. It’s always a good idea to have a plan for paying down debt, but it’s even more important to get out in front of a looming recession by ensuring that your high-interest debt (like credit card debt) is under control. This can help you be better equipped to face a potential strain on your financial resources, such as the loss of a job or a drop in income.

5. Consider refinancing debt

Refinancing debt, such as your mortgage or student loans, can also help you save money and prepare for a recession. By refinancing to lower interest rates, lower monthly payments, or both, you may be able to free up some extra cash for your emergency fund and other expenses.

6. Diversify your income streams

Having multiple sources of income may also help you get through a recession. If you have a side hustle or a freelance gig, consider expanding it to generate more income. Otherwise, look for new income streams, such as renting out a spare room, selling items you no longer need, or monetizing a hobby.

7. Invest in your education and skills

Investing in your education and skills can help you remain competitive in an uncertain job market, even during a recession. Try taking classes or attending workshops that can improve your professional skills or that may lead to a new career path. By diversifying your skills, you may be a more attractive candidate to potential employers.

8. Prepare for job loss

As mentioned above, job loss is unfortunately a common occurrence during a recession. While you don’t need to panic, it doesn’t hurt to make sure you’re prepared by updating your resume and professional profiles online, reaching out to your contacts, and monitoring relevant job markets. Maintaining a list of attractive job openings can make it easier to apply quickly with your research already done.

9. Invest in quality assets

Provided your budget allows for it, investing in quality assets that can provide future financial stability, such as real estate, may help you weather a recession. Likewise, acquiring these quality assets during a recession can sometimes be done at reduced prices, which may increase in value as the economy starts to recover.

10. Stay financially disciplined

During a recession, it's vital to stay financially disciplined to help you weather the storm. This means keeping your eye on the ball when it comes to maintaining your budget, managing your debt, and building up your savings. As for your long-term financial goals, you can still stay focused on them during a recession, and adjust as needed to compensate for factors like reduced income without putting them on pause or giving up on them altogether.

It’s understandable to look at a recession as a frightening prospect, especially given that it can severely impact every aspect of the economy. However, by taking these steps to protect your finances and your future, you can be more prepared to ride out the next one and potentially even emerge stronger at the other end.

Unless otherwise noted above, opinions, advice, services, or other information or content expressed or contributed by customers or non-Varo contributors do not necessarily state or reflect those of Varo Bank, N.A. Member FDIC (“Bank”). Bank is not responsible for the accuracy of any content provided by author(s) or contributor(s) other than Varo.