How to Prepare for a Recession

The likelihood of a recession is shrinking. Economists surveyed by the Wall Street Journal in January now think there’s about a 39% chance that one will occur in the next 12 months—down from nearly 50% in October. Still, economists expect growth to be slow and to vary by industry. If you’d bring an umbrella with the same chance of rain on the forecast, you might want to prep your finances for a potential recession, too.

“We don’t really know that the scenario that we plan for will ultimately be what occurs,” says Ross Hamilton, a financial planner at wealth manager Raymond James in Bethesda, Md. “But if you’ve planned a little bit ahead for a variety of scenarios, it does allow you to take action when the time comes.”

The first event to plan for is getting laid off, Hamilton says, since job loss is the biggest risk most people face in a recession. In that scenario, if you aren’t armed with at least an emergency fund and a flexible budget—most Americans aren’t—the impact on other areas of your life can be devastating.

But a recession brings other threats too, like the potential for major stock market swings that can derail financial goals. Here, experts recommend strategies to brace for impact.

What is a recession?

For all the attention paid to recessions, the term is surprisingly broadly defined. The National Bureau of Economic Research, a nonprofit research group entrusted with identifying recessions, describes it as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

In other words, it describes the period after the economy has reached its peak. On a graph, it would appear as a downward sloping line. As soon as the line begins to tick upward again, the economy exits a recession and enters an expansion.

Eight economists make up the NBER committee that evaluates whether and when the U.S. economy was in a recession (the determination typically happens months or years later). According to NBER, most recessions are brief. In fact, the most recent recession was just about three months, coinciding with the start of the Covid-19 pandemic in February 2020 and ending that May.

Are we in a recession or is a recession coming?

The committee that calls recessions doesn’t do so in real time. If we are in a recession, it will likely be months or years before it’s formally recognized with specific start and end dates. Still, many experts don’t think we are in a full-blown recession—yet.

No two recessions are the same. The coronavirus recession was brief and followed by a period of surprisingly strong growth. On the other hand, the previous recession—the so-called Great Recession—lasted 18 months from December 2007 to June 2009 and led to record-high unemployment, depressed consumer spending, major stock market losses and a significant drop in home values.

How to prepare

Preparing your finances for a recession isn’t all that different from practicing good money habits in your daily life. Here are the most important areas to pay attention to.

Your career

It’s not uncommon for entire industries to be affected by a widespread economic downturn. Companies sometimes have to lay off workers to cut costs. Whether or not you believe you’re in a secure industry or at a secure company, get a head start by updating your resume now, Hamilton advises.

Having an up-to-date resume is a simple way to give yourself a little more confidence if you suddenly need to find a new job. “You’ve just removed one small thing from the checklist that you’re going to have to deal with,” he says.

Your insurance

Eric Roberge, a Boston-based certified financial planner and founder of Beyond Your Hammock, says it’s crucial to consider what workplace benefits you could lose, such as health insurance, and make a plan to replace them.

More than half of the U.S. population had employer-based health insurance in 2022. Losing your job could qualify you to join a spouse’s health plan or enroll in Cobra, the federally-mandated insurance continuation program, to get temporary, albeit expensive, coverage.

Many corporate jobs also provide affordable group life and disability insurance policies. Life insurance gives your loved ones a cash payout if you die and disability insurance replaces some of your income if you can’t work because of an illness or injury. It’s easy to forget you have access to these benefits since employers subsidize the cost. But if your employment is terminated, your insurance policies will likely be too.

“If something happens to you while you’re unemployed and you need that coverage, you or your family are going to be in financial trouble,” Roberge says.

In some cases you can take your policy with you, but your rate may increase. Or you can purchase a term-life policy, where you lock in your monthly payment for the duration of the coverage period (usually between 10 and 30 years). For most people this is the most affordable form of life insurance coverage. Disability insurance can be pricier, but there are ways to customize your coverage to keep costs down.

Your budget

Megan McCoy, a professor of financial therapy at Kansas State University, says people often let their guard down when they suspect an economic storm is ahead. This can lead to counterproductive behaviors like impulse spending. “It’s like, ‘Oh, the recession’s coming, so I might as well just spend money now because there’s no hope,’ or ‘I might as well buy all this stuff now before the cost of it goes up,’” she says. “They almost give up on their goals.”

Instead, McCoy suggests doubling down on your financial goals and focusing on the big picture. To avoid making panicked decisions later, look at your fixed expenses—especially the big three: housing, transportation and food—and determine what you would be willing to cut from your budget if your income decreased or disappeared. Think of it as a backup spending plan that you can activate at a moment’s notice.

You’ll likely have to make some real-time adjustments to meet short-term goals while enduring a recession, McCoy says. But thinking through those options now means you won’t have to scramble for a solution when emotions are running high.

Your savings

Whether you expect a recession to impact your employment or not, an emergency fund is a must. You can tap it as a source of income between jobs or to pay for a surprise expense. Experts say a healthy emergency fund has at least three to six months worth of expenses in a high-yield savings account or a money market account. Some people may feel more comfortable with a higher number.

If you’re anticipating a recession, it’s best to let go of the notion that holding a lot of cash means sacrificing investment returns. If you make it through the crisis with more cash than you need for a sufficient emergency fund, you can invest some of the excess.

“The beauty of emergency funds is that having too much savings is an easily solvable problem,” Hamilton says. “If you don’t have enough savings, it’s really hard to fix that.”

Plus, the best savings accounts currently offer rates near or above 5% and let you access your money without paying a penalty. “For the first time in years you’re actually getting paid to have an emergency fund,” Hamilton says.

Building savings from scratch can feel daunting. First, check that there are no “leaks” in your spending, McCoy says. That means identifying nonessential recurring purchases, pressing pause and redirecting that money into a savings account. “There’s a great percentage of Americans who are living paycheck to paycheck, but there’s also a great percentage of people who are spending their whole paycheck without having to,” McCoy says.

If there’s truly no wiggle room in your budget, think about taking on a side hustle for additional income or reducing your fixed monthly costs by getting a roommate or moving in with family temporarily, McCoy says.

Your credit

An emergency fund should be your first line of defense if you need quick cash during a recession. If your savings run dry, borrowing could be your next best option. Do what you can to raise your credit score now so that you’re in the best position to qualify for low interest rates if the need for a loan or line of credit arises.

Your credit score is a product of many factors. The two most crucial are your payment history and the amount of debt you owe.

Focus on paying down any existing debt with on-time payments. And consider putting plans that require financing, like buying a new car or starting a home renovation, on hold. “Finding ways to preserve capital and not take on more debt is really the ultimate objective,” says Hamilton. “You want to give yourself as much flexibility and leeway as you can get.”

Your investments

Ideally you want to organize your investments so that during a recession you are comfortable enough to “sit on your hands and kind of let the market do what it’s gonna do,” Hamilton says. In the grand scheme, the most successful investors avoid fear-based decisions and stick to their plans.

So how do you do that? Review your current holdings and ensure that they match your current risk tolerance and time horizon. Funds you won’t need for at least 10 years are considered long term, so can be left in riskier assets.

“The shorter your time horizon, the more a potential downturn could disrupt your overall plan,” Roberge says. “If you have a five-year time horizon and you look at your portfolio and you’re invested in 100% stocks, that’s not a good setup for a looming recession.”

Hamilton suggests performing a stress test on your portfolio and risk tolerance by converting potential losses into dollars. Say the total value of your 401(k) is $100,000 and it’s invested in an S&P 500 index fund. If the stock market were to drop 20% over a four-week period, that’s a $20,000 loss, for example. If you think that loss would spook you into selling your investments to avoid further losses, you might consider moving some money into less volatile assets, like bonds.

Keep in mind: For every investor, risk tolerance exists on a spectrum. What you’re comfortable with on a bluebird day is going to be different than what you’re comfortable with when the stock market is in free fall.

Your home

There’s no telling how the housing market will react during the next recession, but one thing is for sure: You never want to be in a position where you’re unable to afford your mortgage.

One way home buyers can get into trouble is assuming that interest rates will go down after a recession hits, Roberge says. “We see many clients tempted to buy more house than they can afford because they think, ‘I’ve heard rates will be lower so we’ll just refinance by the end of the year,’” he says. “Focus on buying the house you can reasonably afford now—not what you think you can afford in the near future.”

Most mortgage lenders require borrowers to have monthly housing costs totaling no more than 28% of their gross income. If you’re buying a house this year, Roberge recommends playing it safe and capping your costs at 20% of your gross income.

“It forces you to keep buffer room in your budget,” Roberge says. “That buffer room is an extremely valuable tool to have at your disposal when it comes to weathering the storms of recessions, emergencies or unforeseen circumstances like job loss.”

Your emotions

Psychologically speaking, says McCoy, it’s natural for logic to take a back seat to emotions when someone is in financial distress or anxious about the future. If you’ve taken concrete steps to protect yourself in the face of a recession and you’re still worried it’s not enough, she suggests seeking advice from a financial counselor or a planner.

“Even though every TV talking head is screaming that things are going bad,” she says, one conversation with a professional could help you feel reassured: “I’m OK. I’m doing the right thing. I’m protected. I have a plan in place.”

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