The last time America was in a recession, banks were within 24 hours of shutting down, the stock market crashed, thousands of Americans were left homeless and unemployed, and many more lost their life’s savings.
This year, we find ourselves in a similar situation, albeit under different circumstances. While the 2008 recession was probably caused by a string of human errors, this year was caused by lockdowns due to COVID-19.
Our economy has been at the mercy of COVID-19 since March 2020, and we all knew back then that recession was imminent. Is there something we can do to protect ourselves from financial ruin?
Fortunately, we can. But to survive a recession, we must first understand what it is.
I. What is a recession?
A recession is defined as two consecutive quarters of negative growth in the economy. It is caused by numerous factors, like financial panics, economic shocks, swift changes in economic expectations, or a mix of all three.
Businesses suffer during a recession simply because the demand for many products and services is lower. Also, there is uncertainty about the future.
There is also a financial risk, risk of default, and bankruptcy.
Recession is a normal part of the economic cycle, and along with it can come real harm. It is important to note that while the economy will start to recover after a recession, it will not go back to its pre-recession levels, at least not in the near future. Individuals affected by a recession continue to struggle after the recession is over. For instance, unemployment rates in the past usually continued to rise even after the economy started growing.
II. Can we predict a recession?
We cannot accurately predict a recession. If so, we would prevent it from happening. Fortunately, there are some warning signs that economists use to tell if a recession is coming. Here are the signs that a recession may be on the horizon.
- High unemployment rates
A high unemployment rate is an example of what economists call a lagging indicator. When more people are losing their jobs, their purchasing power decreases, creating a huge void in the economy.
- Inverted yield curve
An inverted yield curve points out the relationship between the yield of a short-term government bond and a long-term government bond. Under ordinary circumstances, the long-term yield will be greater. If the yield curve is inverted and the long-term yield is lower, that can warn economists of a lack of faith in the economy and that a recession may not be far behind.
It should be noted that an inverted yield curve has preceded every U.S. recession since 1970.
- Decline in manufacturing jobs
Low demand for manufactured goods can be a manifestation of diminished consumer spending. If factories cut employees or stop hiring new ones, that can mean reductions in other industries are next.
Other leading indicators are a contraction in the stock market, declining home prices, and a dearth of new small businesses.
III. Preparing for a recession
A recession is a part of the normal business cycle. It is an economic reality and there is no way to avoid it. There have been 13 recessions in the United States since the Great Depression, so that is more than 1 per decade on average.
According to the Motley Fool, millions of Americans still have not recovered from the Great Recession of 2008, and perhaps some never will. But there are ways to prepare for a recession, and here is what you can do.
- Pay off your debt
Many people ask if they should pay off their debt during a recession. The answer is yes! Give more importance to high-interest debt, and then keep your other debt to a minimum.
If you pay off your high-interest debt, you will reduce your monthly expenses. Thus, you will have more money for necessities and savings.
They say your best investment is in yourself. Try to learn new things and maybe add a new certification to boost your resume. Many people struggled to find work during and after the last recession. Employers cut costs by letting go of employees they feel they can do without and hire the ones possessing skills that they need.
- Set aside money for emergency savings
It is advisable to set aside at least 6 months’ worth of expenses for your savings. That would mean you will have enough money to pay for food, utilities, housing, and other financial obligations.
Of course, building up emergency savings will take time. Once you reach your six months’ worth of savings, you can continue saving until you reach a one-year-savings goal. Your aim should be to keep on saving until you have enough for retirement.
- Build your portfolio
The stock market tends to drop during a recession, so it is best to build your portfolio for the long-term. Moreover, the market also tends to recover quickly too.
Inexperienced investors tend to panic during a recession and sell their stocks or mutual funds expecting that their stocks will fall down the drain. Unfortunately for them, the stock market usually recovers quickly and as a result, they miss out on wonderful opportunities.
Wise investors take the “buy and hold” approach when investing in stocks. They are never in it for immediate gratification. Instead, they think 5 years ahead, some even 10 years. By thinking of the long-term, you would not be making the mistake of selling at the worst time.
- Plan to buy stocks during a recession
It may seem counterintuitive to the average person, but smart investors continue to buy even during a recession as it gives them the best opportunities for investing. You should find it useful to put aside some funds during strong economic times so you can invest accordingly during a recession.
It is futile to attempt to predict a recession. Even the best economists are not able accurately predict its arrival. And no matter how much we try to avoid it, it will come. History tells us so.
The hard truth is that we may lose money during a recession, so the best thing to do is to be prepared. Be calm and follow the advice above so that you will be better equipped than anyone in the face of a recession.