How to Recession-Proof Your Finances

Recessions are inevitable, and given the current economic crisis being caused by COVID-19, another one seems imminent. The World Bank predicts that the global economy will shrink by 5.2% this year, resulting in the worst recession since after World War II.

Recession-proofing your finances means that you prepare for the worst so you can maintain stability through economic downturns. This can be challenging amidst stay-at-home-orders and business closures, but if you’re still on stable financial ground now, these tips can help you get started.

How to prepare for a recession

Recessions bring higher unemployment, increased risk of layoffs, and lower tips and commissions. In the last recession, full-time employees even had their hours cut, often to 4-day work weeks. So, you need extra savings to pad your financial safety net.

Systematically minimize debt levels

Pay off credit card debt first

Start by eliminating high interest rate credit card debt first. Ideally, you want to maintain zero balances from month to month. So, everything you charge in a month gets paid off within that billing cycle. This not only minimizes interest charges but also helps protect your finances from risk during a recession.

If a recession hits, you don’t want excess credit card debt hanging around. It gives you less breathing room in your budget because you have more obligations to cover. If the worst happens and you face job loss, credit cards are often the first debts to slip into default.

That means if you believe a recession may hit later this year, you should take steps now to eliminate credit card debt. If you can’t pay off balances using a debt reduction plan in your budget, consider relief options:

1. Credit card balance transfer
2. Unsecured personal debt consolidation loan
3. Debt management program

Then focus on student loans

Once you have credit card debt out of the way, focus on any student loan debt in your household. If you have multiple federal loans to repay, consider a federal repayment plan. There are two plans (standard and graduated) that are designed to help you pay off student loan debt “quickly.” However, the term on these programs is ten years, so it’s not exactly fast. It’s just faster than other relief programs that have terms of up to 25 years.

If you really want fast student loan repayment and you have a good, steady income, the best option is student loan refinancing. You can use refinancing for federal and private student loans. This will give you the shortest term so you can really get out of student loan debt fast.

However, just be aware that this converts federal loans to a private loan. You will no longer be eligible for federal student loan relief. If the recession hits and you lose your job, that could be a problem. So, consider this carefully before you take this step.

Finally, be careful with risky auto loans

While some experts believe student loans will be the debt at the root of the next recession, others worry it will be auto loans. Many of the risky lending practices that caused the housing crisis in 2008 have migrated to the auto industry.

• If the economy takes a turn and you have a long-term auto loan (6 years or more), you may end up stuck with a loan you can’t afford and a car you can’t sell.
• If you have a variable rate loan, you also need to be concerned. Rates could increase suddenly just like they did on adjustable-rate mortgages at the start of the 2008 crisis.

If you’re in either of these situations with an auto loan, refinance now. Your best bet is to get the debt paid off in case the auto loan bubble really does burst.

Expand your financial safety net

In normal circumstances, experts say you should have 3-6 months of bills and budgeted expenses covered in savings. For example, let’s say your bills and necessary expenses cost $1,500 per month. A good emergency fund would be $4,500 to $9,000. This would allow you to maintain your budget without credit even if you lose your job for up to six months.

However, during a recession, 6 months may not be enough. During the Great Recession, people were unemployed for up to a year or more, on average. So, experts now say that if you anticipate a recession, you should save up to 1 year of expenses. Ideally, you want $18,000 in easily accessible savings accounts.

If that sounds excessive, just remember what this money is supposed to cover. The idea is that you can live on savings until you get a new job if you face a layoff. No massive run-up of credit card debt; no payday loans with ridiculous interest rates. You enjoy financial peace of mind even without full-time employment.

What are the best savings accounts for a recession?

The best savings account to have during a recession is a fixed-rate savings account that you open now. Over the past two years, the Federal Reserve has increased the federal funds rate about seven times.

That’s the benchmark rate that financial institutions use to set base rates for loans and savings accounts. So, interest rates on loans are on the rise, but so are rates on savings accounts. You can find savings accounts right now that offer a 2% Annual Percent Yield (APY); that’s the interest rate on a savings tool.

If the economy takes a turn, the Federal Reserve will lower the federal funds rate. The idea is to encourage people to borrow to spur the economy. But that will also drop the APY you can find on savings tools. That’s why you want to get a fixed-rate savings account now. Get the account while rates are at their highest.

Also, be aware that if you have a variable-rate savings account, such as a Money Market Account, your growth will likely slow during the recession. The high rates you may be enjoying now won’t last if the economy takes are turn. That’s why fixed-rate accounts are your best option heading into a potentially weak economy.

3 key takeaways from the Great Recession

A recession savings question from a Debt.com reader…

Question: My husband and I have read many articles by you and other experts that predict a recession is coming soon. We’re very scared about this, as we barely survived the last recession. We still haven’t paid off all the debts we incurred during that time period.

My husband read this article on the Fox Business website and wants to invest in silver stocks. He wants to divert the $50 a month we put into an IRA we have for retirement. This doesn’t feel right, but I can’t explain why it feels wrong. What do you think?

— Regina in Texas

Howard Dvorkin CPA answers…

When I originally wrote we’ll suffer another recession during President Trump’s first four years, I was worried. I wanted Americans like you, Regina, to know what might be coming – and get ready for it. However, I didn’t want to cause panic or even angst.

I have a formula: Preparation plus time equals inner peace.

So you can indeed prep for the next recession, but you don’t need to take hasty risks like investing in precious metals. Only a few months ago, I told another husband not to buy gold on his credit card. Now I’m telling your husband not to stop saving for retirement to buy silver.

What I wrote about gold also applies to silver or any metal: Prices fluctuate wildly, they’re impossible to predict, and you can lose your entire investment if you’re not careful.

Even worse, you seem to imply, Regina, that you still have credit card debt that you’ve been carrying since the last recession. Your first priority should be paying that off. If your husband is unconvinced, tell him to think about it this way…

• Silver has a 16 percent annual rate of return, although that can fly in either direction at any given time. You might make 200 percent, or you might lose 100 percent.
• The average interest rate on a credit card for someone with good credit is around 15 percent. It balloons to 21 percent for those with fair credit. It sounds like you might be somewhere in the middle, Regina.

…so paying off your credit cards will put just as much money in your pocket as investing in silver, and without the risk.

Investing in the stock market is something you should only do when you have money you don’t desperately need. Even then, it’s folly to buy individual stocks or even stock funds that are invested so narrowly in industries you and your husband know nothing about.