If 2022 was the year of resurgent inflation, 2023 could be the year of recession — or at least a bumpy landing.
The economy still hasn’t recovered, and maybe not, but many warning signs are flashing.
So it’s a good idea to prepare. Here are some suggestions on how to do that if an economic downturn hits:
1. Keep debt under control
This is wise advice at all times, but borrowing money can pose greater risks during recessions if you lose your job, suffer a large investment loss, or face other economic pressures.
There are a few approaches to debt settlement. One emphasizes paying off small balances first to build momentum – a sense that you’re making progress. Another focuses on cutting the highest-interest-rate bonds first.
“Minimizing your interest costs means paying down debt from the highest interest rate to the lowest, but you have to do what works for you,” said Greg McBride, chief financial analyst at Bankrate.com. “If you’re more likely to stick with the program by paying out a few smaller balances first to build some momentum, and then do that.”
He also suggests looking for incentives like 0% balance transfer offers, some of which last up to 21 months if you can’t pay off your credit cards in full each month.
2. Check your loss tolerance
Investment typically falls during recessions, at least in the early stages. With hints of recession in the air, many assets have faltered over the past year, from home prices to stock and bond values to cryptocurrencies.
The stock market, represented by the Standard & Poor’s 500 Index, fell about 19% last year. A second consecutive annual decline of this magnitude would be unusual. Also, stocks and bonds don’t usually fall in unison like they did in 2022.
Rather, the stock market tends to recover from slumps even during recessions. After 18 previous years of declines through 1950, the S&P 500 index recovered for 15 of the following years, according to research by LPL Financial. “Looked at another way, after losing 20% or more at any point over the following 12 months, the S&P 500 has gained an average of 17.6%,” said LPL Financial.
The stock market ended 2020 down 19% but was down 25% at the bottom.
In any case, a new year is a good time to rebalance or move some money from relatively stable stocks to those that have been crushed. The idea here is to make incremental adjustments. Your portfolio should reflect your ability to tolerate or manage risk, but you want to avoid drastic changes that could be near cyclical bottoms.
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3. Build your liquidity
Recessions can take a toll on finances, so it’s important to have enough savings to cover unexpected expenses. The usual recommendation of having three to six months of emergency savings on hand rises to six to nine months during recessions.
“Having less debt and more savings will better enable you to weather any economic environment that lies ahead,” McBride said.
Candy Valentino, a Paradise Valley entrepreneur and author of the book Wealth Habits on personal finance, suggests reviewing your credit card and other bank statements once a month to reduce spending by 10%. Be on the lookout for subscriptions or memberships you signed up for but no longer use, frivolous phone apps that cost a few bucks, excessive restaurant meals, and other entertainment expenses.
“Go line by line and look at your credit and debit card statements,” she said. “It’s amazing how many charges can sneak up on you.”
It’s also a good time to check your credit reports for errors and review the various loans on your behalf, including credit card accounts that you may have forgotten. A solid credit history translates into higher credit scores and the ability to get credit on good terms when needed.
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4. Reevaluate your job prospects
Unemployment usually rises during a recession and this is the factor that usually causes most misery. So far, however, that hasn’t happened, much to the dismay of Federal Reserve leaders, who want to curb inflation in part by raising the unemployment rate. But if a recession hits, unemployment is likely to rise.
Aside from possibly finding a new job, it may be time to update your resume and improve professional skills. Adding a second or gig job might also be helpful. In addition to extra income, a part-time job opens up tax-saving opportunities such as deductions for business meals, trips, a computer, supplies or a home office, Valentino said.
Despite persistently low unemployment and plenty of job vacancies, workers and job seekers should not get cocky. Bill Adams, Comerica Bank’s chief economist, notes that the quality of job openings has declined, with layoffs increasing in higher-paying industries like tech, finance and manufacturing, while hiring continues in lower-paying areas like leisure and hospitality.
He sees the country’s unemployment rate rising from the current 3.5% to 4.5% by mid-2023.
5. Delay retirement if you can
As you approach retirement age, it may pay off to hold out for another year or two. Granted, it looks like everyone else is quitting or retiring, but staying busy for a while longer can help lighten your retirement portfolio a bit, especially during a recession.
“A few extra years in the workforce can make a big difference,” the Center for Retirement Research at Boston College found in a report that identified three key benefits. The first: Put more money into a 401(k) or similar retirement plan. The second: further deferral of social security for people aged 62-70 with a corresponding increase in eventual benefits. Third: Reducing the number of years of retirement your portfolio will take to last.
The last point is worth emphasizing in times of recession, when financial markets are often in disarray.
A study by the Vanguard Group examined the results of two investors with hypothetical $500,000 portfolios at the start of the severe, recession-induced bear market of 1973-1974. Both investors were withdrawing $25,000 a year and had similar portfolios split 50:50 between stocks and bonds. But one investor began retreating in 1973, at the start of a 21-month period that saw the market plummet 46%. The other started a year later in 1974. The delay was critical because the first investor ran out of money after 23 years, while the second still had some assets left after 35 years.
This is known as sequence-of-return risk and reflects the danger of turning temporary paper losses into permanent setbacks that can take many years to recover from. Recessions are a time when this risk increases.
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