Financial Mistakes You Can Make Around a Recession
Wondering how to prepare for a recession? It’s wise to start by avoiding common mistakes made during economic declines. Here’s what you need to know.
August 19, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
Recessions occur when there is a slowdown in economic activity. They are notoriously difficult to predict, but they do tend to occur as a natural part of the economic cycle.
While none of us can prevent a recession from happening, we can take steps to prepare. This guide will go over how to prepare for a recession by taking steps to strengthen your personal financial situation.
What is a recession?
A recession is a period of temporary economic decline, in which trade and industrial activity decrease. It’s essentially when economic activity slows down for a period of time — which can be anywhere from a few months to a few years. On average, recessions have lasted around 15 months.
Technically speaking, a recession is defined as a drop in gross domestic product (GDP) for at least two consecutive quarters (six months).
How could a recession impact me?
Recessions result in a slowdown of economic activity. This can lead to job losses, closed businesses and more.
The biggest risk to individuals is job loss. As companies tighten their belts to weather the financial storm, layoffs are always possible.
Another impact can be seen on your investment portfolio. Asset prices tend to decline during recessions, with stocks and other risk assets hit particularly hard.
When a recession is paired with inflation, rising prices are also likely to occur.
7 mistakes to avoid in a recession
If you suspect that a recession is coming, there are some common mistakes to avoid. And though we can’t predict recessions with any accuracy, these are also good general mistakes to avoid when it comes to personal finances.
Not prioritizing your career
It can be easy to take your career for granted. But in a recession, nobody’s job is fully safe. It’s wise to examine the health of your company, the risk of layoffs in your industry and other factors that could affect your potential livelihood.
Some industries are much more recession-proof than others. Healthcare workers are unlikely to be laid off, for example, but tech workers in startup companies could see their jobs vanish overnight.
How do you reduce your risk?
Keep your resume updated.
Invest in professional development by obtaining certifications or attending conferences in your field.
Network in your industry to keep connections alive.
Step up your performance at work and take steps to be noticed by upper management.
Making knee-jerk reactions around investments
Stock market declines or even crashes often come hand in hand with recessions. And when you see the value of your assets declining, it can be tempting to make a rash decision and sell.
This is almost always a mistake. One of the principles of investing is to make a long-term plan and stick to it. If you sell during a recession, you are disrupting your plan — and could end up losing money.
If you sell assets at a loss, you are locking in that loss. Then you need to determine when to buy back in — which is almost impossible to do.
Take the COVID-19 recession in early 2020, for example. Stocks dropped more than 30% in a matter of months, but quickly recovered less than six months later — far earlier than almost anyone predicted.
Ignoring your emergency fund
An emergency fund is a chunk of money set aside to cover unexpected expenses, or to provide a cushion in the case of a loss of income.
It’s important for everyone to have an emergency fund, but they are particularly vital during recessions. Most experts recommend having between three and six months of living expenses set aside. So if your household spends $4,000 per month, a goal would be to have $12,000 to $24,000 set aside in an emergency fund.
If you don’t have money set aside yet, read through our guide on how to start an emergency fund.
Keeping your emergency fund in liquid savings, like a savings account will enable you to have easy access to these funds. Investing your emergency fund would require extra time to access the funds at a time when you might need them quickly.
Not revising your budget or cutting expenses
Another step in how to prepare for a recession is taking a look at your budget. Where is your money going, and how might you be able to cut back?
Anything you can do now to save a bit of extra money will be helpful in the case of an economic decline. Plus, by proactively cutting expenses, you can reduce your ongoing monthly expenses and make more room in your budget for savings.
Don’t yet have a formal budget? Read through our budgeting 101 guide to learn more.
Getting behind on debt repayment
Keeping up with debt payments is always important. Missing payments will ding your credit score, and also add late fees and penalty APRs to your costs. A recession could also affect your debt, possibly by raising your interest rates.
If credit card debt is holding you back, check out Tally† Tally is an app that helps qualifying applicants consolidate credit card balances into a lower-interest line of credit. Learn how Tally works.
For other forms of debt, staying on top of your monthly payments is important. Setting up auto-pay is wise, to prevent accidentally missing a payment.
And if you do end up losing your job, contact your lender(s) ASAP. Many lenders have some flexibility in adjusting payment schedules or providing other forms of debt relief — but you have to be proactive and ask.
Not having a plan
Making a plan for worst-case scenarios is always wise. What will you do if you lose your job or your spouse loses theirs? What if you both lose your jobs?
An emergency fund will likely be the first thing you fall back on. But beyond that, it’s helpful to consider other options. Could you tap into a home equity line of credit (HELOC) to cover financial gaps? Could you ask friends or family for financial assistance, if need be?
Having a plan in place can help ease anxiety and provide an actionable list of steps to take should things take a turn for the worst.
Relying on one source of income
If your household relies solely on a single source of income, that can be a recipe for trouble during a recession. It’s wise to expand your income streams, perhaps through a side hustle or part-time job, through investments, or even by owning a rental property.
The more you can diversify your sources of income, the more recession resistant your personal finances could be.
Is a recession coming?
It’s impossible to predict whether or not a recession is on the horizon.
But here’s the honest truth: One is absolutely coming — we just don’t quite know when.
Looking back, the U.S. economy has had 13 recessions since 1933 (the end of the Great Depression). That’s one every 7 years, on average.
So whether there’s a recession coming this month, this year or this decade is tough to say — but having a plan in place is always wise to protect your finances.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.