Budgeting for a Recession: The dos and don’ts for weathering a financial storm.in Managing Money & Credit
The term recession has become a hot topic of discussion over the past 12 months. Financial analysts, politicians, and news outlets have all discussed the possibility of a strong economic downturn. These predictions, along with skyrocketing inflation, have understandably left many Americans feeling concerned about their financial future.
Fortunately, there are ways to work with your budget to help prepare your finances for an uncertain future. Following these recommendations — avoiding some others — can help put you in a strong position to weather any financial storm.
What Does an Economic Recession Look Like?
According to the White House, economists determine whether the economy is in a recession by analyzing various data points, which includes consumer and business spending, labor market, incomes, and industrial production.
The National Bureau of Economic Research Business Cycle Dating Committee (which officially determines if the country is in a recession or not) assesses each of these variables. It can be challenging to gather all the necessary data in real-time, so often they can only declare a recession once it’s begun.
For the everyday consumer, a recession might look like:
- Job loss or wage cuts as companies cut their expenses
- A decrease in purchasing power due to goods and services being more expensive
- Stock market decreases causing investments to decrease significantly
- Higher monthly payments as a result of a rise in interest rates
These are just four consequences of a hurting economy that can be devastating for the average person. Therefore, having a strong budget and knowing what to avoid during a recession are crucial to weathering the markets.
When using a credit card, you’re borrowing funds from the financial institution that issued you the card. In other words, you’re using the lender’s money to pay for purchases up front rather than your own. By doing so, you are then obligated to pay off the charges made on your card, either in full or with regular smaller payments that are a portion of your balance by a predetermined due date (usually monthly). If you do not pay the balance in full and opt for the monthly payment option, you’ll be charged interest on the amount borrowed.
Assessing Your Current Financial Health
Whether entering an official recession or not, it’s important to have an accurate understanding of your current financial health. Before you can implement budget strategies, you need to know where you’re starting from.
Set aside time to thoroughly review your current financials — and if you share finances with a partner, be sure to invite them, too!
Here are a list of action items needed from you:
- Calculate your net worth
- List your income and expenses
- Add up your debt
- Assess your investments and savings
Calculate your net worth
Think of this number as a snapshot of your current financial health. Your net worth equals:
Total assets (-) total liabilities
Assets include your investments, savings, cash, commodities, property, etc. Liabilities include any debt you carry including your mortgage loan, student loans, credit cards, etc. This number will give you an idea of where you stand financially.
List your income and expenses
Next, add up all the income you earn each month from your primary job, side hustles, investments, rental income, etc. Then, add up all your expenses. This could take a while if you don’t regularly track your expenses, but it’s a worthwhile investment to see if you’re living within your means and determine how much money (if any) you have left each month.
Add up your debt
This should be fairly straightforward since you’ve already calculated all of your liabilities. List out all of your debts including any principle, interest rate, and monthly payment amounts.
Assess your investments and savings
It’s important to know how your investments are performing to see if they need rebalancing. You’ll also want to know how much cash you have and how liquid it is.
Assessing these four areas will give you an idea of where you stand financially and what areas need the most improvement.
Five Recommendations on Budgeting for a Recession
Adequately preparing your budget for an economic recession takes time and diligence, but with focus and determination, you can put yourself in a strong financial position.
Here are our top five recommendations on budgeting for a recession:
- Decrease your debt
- Give your budget a check-up
- Make room for savings
- Tend to your investment accounts
- Increase your income
Decrease your debt
One of the biggest factors impacting your budget is your monthly debt payments. If you currently have a strong income with some disposable money each month, consider paying down your debt, especially those with high-interest rates. That way, if you end up facing a wage cut or become unemployed, you won’t have as many liabilities to worry about.
Pay your debt off quickly by:
- Making extra payments
- Make large payments to your highest-interest debt first while paying the minimum on your other debts
- Consolidating your debt
- Negotiating with your creditors
Paying off debt can feel insurmountable. But by having a positive mindset with proven debt-eliminating strategies, you can work toward unloading this unwanted weight! Start by assessing your monthly budget and seeing where you can cut spending.
This “extra” money can be used to pay down your debts. And remember, when you finally get the debt paid off, you can alter those payments toward your emergency fund, long-term savings, or retirement.
Give your budget a check-up
If you’ve never budgeted before, this step will require a bit of extra work, but it’s well worth your time. Review the last three months of your expenses and categorize them into groups such as housing, clothing, food, services/memberships, debt payments, travel, etc.
Compare these monthly expenses to your total monthly income to see if you’ve been living within your means or overextending yourself. Note: budgets are highly personal and not everyone will agree with what is essential and non-essential. It’s up to you to determine what you can and can’t live without.
It’s important to assess your spending habits with your goals. Be honest with yourself and whether or not your spending amounts reflect your priorities.
Many everyday spending categories can often be trimmed, such as:
- Eating out: pack your lunch and/or learn how to cook your favorite meals at home
- Transportation: consider carpooling or using public transportation
- Utility costs: ask about non-peak budget plans, turn off lights, and take short showers
- Cancel your subscriptions: choose one or two that you use frequently and cut the rest
- Travel closer to home: drive instead of fly, and take a staycation
- Buy gently used clothes: utilize consignment and thrift stores
Choose as many as you can and get creative on changing your spending habits so you can free up space in your budget.
Make room for savings
Saving during a recession might feel like you’re pouring water into a leaky bucket. However, it’s imperative that you continue to be diligent in your savings habits and even prioritize saving over other categories.
Your savings can provide you with a safety net when tough economic times hit. A fully-funded emergency fund, ideally 3-6 months’ worth of expenses, should be in a liquid account earning interest.
If you don’t have a fully-funded emergency fund, take the extra money you saved in step two and contribute to one each month.
Ideally, your budget should also include short and long-term savings goals. Recession or not, there will always be needs throughout each life stage. Ensuring your budget is serving both your present and future needs is essential for a strong financial position.
Tend to your investment accounts
One important line item in your budget is the money you set aside for investing. Over the long term, investing is a powerful way to provide for your future and protect yourself against inflation.
Investing during a recession can still feel scary, especially if you’ve never lived through a major downturn before. However, when the stock market is down, think of stocks as “on-sale”. Your money can buy more shares during a recession and when the stock market goes back up again (on average it’s returned 10% per year for the last century) you’re more likely to have a healthy portfolio.
You could also consider investing in areas that tend to do well during recessions such as consumer goods, utilities, healthcare, real estate, and precious metals.
No investment is ever guaranteed, but there are strategies you can follow, even during tough economic times, that can help you build wealth. Investing is typically a long game, so choose your strategy wisely.
Increase your income
Your budget can only take you so far. At some point, you may realize that although you’ve paid off your debt, cut spending, and set aside money for saving and investing, you still could use more wiggle room in the budget.
There are multiple ways to increase your income:
- Create a small business from a hobby you already enjoy
- Teach a class
- Rent out a portion of your living space
- Pick up a side hustle on nights and weekends
- Work extra hours at your current job
- Ask for a raise
- Sell clothes and household items you no longer need
- Create (and sell) intellectual property such as an e-course or book
- Modify tax withholding (instead of receiving a large refund during tax season, consider only paying what you actually owe and receive higher paychecks)
- Apply for a promotion
This is also a great time to update and polish your resume. Take some time to list/edit your skills, experiences, and accomplishments in case you experience a sudden layoff.
Continually networking and increasing your training/skills will also make you more marketable in a rocky labor market.
Four Financial Actions to Avoid Before and During a Recession
With these five recommendations in mind, consider the following financial actions to avoid before and during a recession:
- Making rash decisions
- Increasing your liabilities3.
- Quitting your job
- Hoping for the best (without preparing for the worst)
Making rash decisions
Fear can cause us to make sudden, knee-jerk decisions, especially when it comes to our finances.
A get-rich-quick investment opportunity may seem like the perfect solution to increasing inflation. A fear-mongering news snippet could cause you to sell all of your shares in the stock market. Or, a threat of increased interest rates could cause you to purchase a home you aren’t ready for.
During a recession, it’s important to make sure you’re not letting fear and anxiety rule your decisions; rather, you should maintain a long-term perspective and recognize that recessions are part of the economic cycle. Reach out to your financial advisor or a trusted friend before making a major decision.
Increasing your liabilities
A recession is not a great time to take on more debt or fixed expenses. With an unsteady job market and rising inflation, it’s best to cut expenses and eliminate debt, not take on more. This is also may not be a wise time to cosign for someone else’s debt. This may be difficult to decline, but you need to ensure you’re in the best financial position possible.
Quitting your job
During an unstable labor market, it’s best to lean into your current job and ensure you’re providing value and continually improving your skills.
Of course, job layoffs can happen to anyone, even if you’ve worked at a company for decades, but generally, it’s best to stay where you’re at and look for ways to increase your value.
Hoping for the best (without preparing for the worst)
Lastly, while we always want to maintain a positive attitude, we simply cannot hope for the best — especially without preparing for the worst. Decreasing debt, giving your budget a check-up, increasing savings, tending to investments, and increasing your income are all fantastic ways to prepare for a recession or any other unexpected event.
Be Financially Prepared with Lafayette Federal
At Lafayette Federal, we offer many different savings options in order for you to reach your financial goals and weather any financial storm. We offer three unique savings account solutions for your needs.
You can also boost your mid-term savings goals with our fixed-rate certificate accounts. We offer various terms at competitive rates. Fixed-rate certificate accounts are held for specific terms, in exchange for higher dividend rates. The minimum deposit for our certificate accounts is $500.