How do I prepare for a recession?

Learn to play defense and then offense in preparing for a recession

First off, its very hard to predict a recession. The agencies who officially declare a recession do so only after the fact because a recession is measured by a backward-looking measure of GDP growth(or decline).  However, there are always some forward looking measures that can help anticipate whether a recession is coming or not. At the time of writing this article in Jun 2022, a lot of those indicators point to a potential upcoming recession (if we are not already in one). So how do you prepare for a recession if I don’t know when its going to come?

My perspective has always been this – how you prepare your personal finances should be the same whether it’s a recession or not. That’s the way to stay resilient. As a personal finance mentor of mine said – “I am always preparing for a recession both during good and bad times”. But often, recessions or the indication of one, give people a wake-up call. Its never too late to do some of these things. If you are already doing these, that’s great. There are a few moves you need to first take that are defensive in nature and once you have that well-set, you can then start to take some offensive moves to take advantage of the situation. Fundamentally, if you don’t remember anything else – remember in tough times, Cash is King!

Getting your defenses in place

So first, go through the below list to ensure you have your defenses in place.

1. Have a robust emergency fund – I talk about this in detail in my article on the emergency fund as a moat to protect your finances. Plan to have 3-6 months or more in cash available for you to access for emergencies.
2. Check your spending – spend less than you earn is an old and tested adage in the personal finance space. But even if you spend less than you earn, it’s a good idea for you to a check-up on whether you are truly optimized in your spending. I explain this in my article on doing a spring-cleaning on your expenses.
3. Create a bare-bones, ‘tough-times’ budget – Once you have done step 2, you should then take a hard look at your expenses and ask yourself which ones I am absolutely going to have to have even if I have a significant loss of income. Your rent/mortgage, utilities are all examples of expenses you may not have flexibility around. You can of course look to optimize those too. But this is where you start to identify all sorts of discretionary expenses that you currently enjoy that you might decide to cut, if times get really bad. We created one like this back in 2020 and we just created a refreshed look at this budget again. So I know which levers I need to pull if and when things might start to get bad.
4. Payoff any high interest or adjustable interest-rate debt – If you are carrying credit card debt or any debt that changes with the prevailing interest rates (and can go up as interest rates go up), start paying them off. In my article on ‘Do I payoff debt or invest’, I explain the framework on how to think about which debt to identify to pay off.
5. Stop looking at your portfolio – you need to shut yourself off the media and the news about the stock market and the markets in general. This might cause you to do stupid and erratic things like sell your investments at a loss. Don’t convert paper losses to real losses. While your portfolio may be down but you need to be a long term investor, so don’t bother with the market gyrations. I talked about this recently in one of my articles on ‘The world is crashing around me – what do I do?”

The above are what I call your defensive moves. If you notice, they are all moves you should be taking irrespective of how the economy is doing. That’s the smart thing to do.

Putting your offensive line in action

Once you have your defenses well set up, its time to start working your offensive actions. Some of these can be done anytime irrespective of the state of the economy.

1. Have cash ready for opportunistic investments – the famous Warrant Buffet adage is so true here – “Be fearful when others are greedy and be greedy when others are fearful”. When people are selling off stocks and the news media is going crazy, you should simply see all this as ‘Stocks on sale’ in a red neon flashing sign. If the S&P500 is down 20% (which is deemed officially a bear market), you simply need to think of it as the S&P500 is now on a discount of 20%. So, what do you do? If you have extra cash (after taking care of your defensive moves) and this fits in your asset allocation, then go right ahead and buy more stocks. My friend asked me yesterday – what if the market goes down further? Should I wait? My response was – you are a long-term investor. These near-term gyrations should not bother you because you are not going to sell for at least another 10-15 years. So, don’t try and time the market. Buy now if you feel it’s a good investment. And if it goes down further, you are getting another discount so buy more at that time if you have the money. This is true of any investments / asset classes btw.
2. Look for ways to strengthen your current stream(s) of income – Most people would argue that this is easier to do when times are good, and I agree. But its never too late and probably more important in tough times. If your current source of income is primarily a W2 income, you should be looking to doing things that ensure your job stays secure. I don’t want to veer off to career advice here – but some of the basics – stay networked in your organization, ensure your work gets the due recognition at least among the people who matter, add value your projects – are all good advice here. If you run a business, double down on staying connected with your customers and building deeper relationships with them. Do the things you think would be needed to protect your current main source of income as best as you can. 
3. Look for ways to diversify your sources of income – This is something I have always been trying to do irrespective of the state of the economy. This is because my primary source of income has always been the W2 income. My concern has always been what would happen to me and my family if our W2 income source dries up. The more income sources you have, the more resilient you can become. Most people talk about replacing their W2 income with other sources of income. Rather than look at it that way, ask yourself how much money you need to meet your expenses and how much of those expenses can be met with different sources of income. You can explore both active and passive sources of income. Popular personal finance blogger ‘Clever Girl Finance’ has written a nice article summarizing this – 3 big ideas to create multiple sources of income. I talk about the idea of becoming financially independent in one of my articles where I talk about a framework for creating passive income to support your monthly expenses. 

Thank you for reading and I wish you success in your financial wellbeing journey.

Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.