A Recession Could Be Coming. Here Are 5 Ways to Prepare

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Recessions can be scary, but read on to find out how to set yourself up for as little financial disruption as possible. 

Recessions can be frightening, but the reality is that they happen every so often, so it’s important to be prepared. With many experts predicting a recession later this year, here are five suggestions to help you get ready.

1. Bulk up your emergency fund

You may have heard that the big U.S. banking institutions have to submit to “stress tests” every year. The purpose of these is to see how the bank would fare financially in a hypothetical deep recession.

It’s wise for people like you and I to prepare for a recession in the same way. In other words, what would your financial situation look like if things got really bad? What if you lost your job? What if the stock market declined by 40%?

Clearly, your finances would likely get considerably worse in situations like this. But that’s where an emergency fund comes in. Experts suggest that you aim to have six months’ worth of living expenses in a readily accessible savings account.

You don’t need to get there right away. Six months’ worth of expenses sounds like a lot (and it is), but even a relatively small amount can help you get through a period of unemployment or other financial stress in much better shape than if you didn’t have the money set aside.

2. Pay down high-interest debt

The average American household has $7,951 in credit card debt, and with the national average interest rate about 24% on credit cards, this means that the typical household is spending (wasting) over $1,900 on interest charges per year.

Not only is paying down credit card debt a generally smart financial move, but not having as much interest flowing out the door can be extremely helpful if you find your cash flow disrupted.

3. Make sure your near-term financial needs are met

To be perfectly clear, a recession being expected is not a good reason to stop investing. Don’t cash out your brokerage accounts or 401(k)s because things might get worse. Trying to time the stock market is a losing battle, and the most certain way to wealth is to stay invested for the long haul.

Having said that, it’s also a good rule of thumb that any money you’ll need within the next few years shouldn’t be invested in the stock market in the first place.

For example, if you’re planning to sell stock to pay for your child’s tuition next fall, it could be a smart move to convert that amount of your portfolio to risk-free investments like short-term Treasuries. This prevents you from losing money right before you need it — after all, if you have $20,000 saved to pay for college, the last thing you want is for it to be worth $15,000 or less by the time you need it, which is completely possible in a bad recession. Besides, short-term Treasuries pay 4%-5% yields right now, so it’s not like you’re completely giving up investment growth.

4. Limit unnecessary spending and use credit cards sparingly (with one caveat)

This is a good financial principle for good times as well as bad, but with a potential recession on the horizon, it can be a smart idea to do a spending checkup. One good exercise to try is to gather your last couple months’ worth of bank statements. Go through each one and highlight everything you didn’t need to buy.

Now, the point isn’t to shame you for spending money on things you enjoy. But many people who actually look at how much they’re spending on unnecessary goods and services are surprised. How much are you spending on dining out each month? Did you find any recurring charges like magazine subscriptions you don’t read or gym memberships you don’t use?

On a similar note, while we already mentioned paying down credit cards, it’s also important to use them sparingly with a recession expected. But it’s also worth noting that banks have historically pulled back on lending during tough economies, and one way they do it is to close inactive accounts. So, if you don’t use your credit cards at all, don’t be shocked if you see your credit limit reduced or your card canceled. If you want to keep your current credit cards, it can help to use them occasionally for a small purchase and immediately pay it off, just to keep the account active.

5. Take a deep breath

As a final item on the to-do list, it’s important to take a step back and not panic. For one thing, panic in tough financial times and uncertain economies leads to knee-jerk decisions, such as moving your 401(k) to cash. There are many people who now regret doing that during the financial crisis of 2008 and the accompanying recession, as the stock market has roughly tripled since that era in the years since.

It’s also important to realize that while painful, recessions are a natural part of the economic cycle. If a recession comes in 2023, it certainly won’t be the last one. The best thing you can do is to be prepared for the next one, whether it arrives in 2023 or not, and use what you learn to prepare even better for the one after that.

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Matthew Frankel, CFP® has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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