Managing Money In A Recession

February 01, 2023

As much as we would love to avoid them, recessions are a natural part of the economic cycle.  Unfortunately, whether we have a recession, how bad it is, and how long it is are all out of our control.  Even the Federal Reserve can try to ease the pain, but they cannot prevent them from occurring.  So, the key is understanding what steps you can take to minimize the pain and put yourself in a better long-term situation. 

Here are some basic steps that you can take to improve your financial resilience during a recession: 

Avoid new debt  

The worst thing you can do in a recession is to add to your monthly obligations.  This is a time to avoid using your credit cards unless you will pay in full and get purchase rewards. If possible, delay major purchases such as a new car or anything you’d buy on credit.  Instead, focus on saving to make any purchase. Then, you may be able to take advantage of discounted prices and/or discounts for paying cash. 

Increase your emergency fund to the next level

The best thing you can do with extra cash is to add it to your savings account. In times like these, it’s critical to have at least one month months worth of expenses in your emergency fund.  While challenging, the peace of mind it can provide in case of a job loss in the household is priceless. If you want to be cautious, double your emergency fund from 3 to 6 months of expenses.  But, only do so if you have good cash flow. 

Use the Saving for Goals calculator to determine a monthly savings goal to reach your new emergency fund goal. 

Cut expenses

One of the easiest ways to prepare for rough times is to start living on less.  By cutting back on a few extras, you can free up the cash flow to build up your savings. Additionally, you can see what you need each month in case your income is reduced.   

If you use a budgeting app or spreadsheet, review your current expenses and see what areas you could cut back for a little while without impacting your necessities.  If you don’t use an app or spreadsheet, use the Expense Tracker to find your trouble spots.  Maybe eat out one less time a month or do a date night at home for a little while. It’s a good exercise to review your streaming services and other subscriptions to evaluate which ones aren’t worth the money. 

Eliminate debt payments

While eliminating most debt is generally a good idea, focus on reducing your monthly expenses.  Look for any small debts you could pay in full within 3 – 6 months and eliminate the payment completely.  Use the Debt Blaster to see how many small debts you could repay in short order. 

Normally you would use the extra money to pay down high interest rate cards.  In a recession, make sure that have – or are on track to have – that extra money in your emergency fund.  If you do, use that extra cash to pay down the credit cards. If not, you may want to build up your savings first.  You can always pay extra on those cards when the economic situation has stabilized. 

Improve your job skills

When the job market is cooling off, make yourself more valuable to your current employer. This will, in turn, make you more attractive to a future employer if you get laid off.  Look for professional certifications or classes you could take or seek out additional training on the job. Remember to check if your employer offers programs to help pay for it. The younger you are, the more this will help you climb the ladder in good times and bad.  As your career progresses, you want to ensure you bring so much value to the table that you’re never considered a potential layoff candidate. 

Buy low on your investments

Consider tax reduction strategies if you have leftover cash flow after these steps. What investment steps can you take today to improve your returns and lower your taxes in the future?   

As scary as it is when things are down, putting more money into your investments makes a lot of sense, as stock prices tend to fall in a recession.  When shopping, everyone wants to get a bargain or a sale price. Thats why stocks often go down during a recession.  That’s the opportunity that recessions usually give us, often making it a great time to invest for a much lower price.  If you have more cash and have taken the other steps, increase your 401k contributions to “buy the market on sale.” 

Sell wisely

Selling investments when they are down can also be a great thing.  First, if the investments are outside of a qualified retirement account (401k, IRA, etc.), you can use the losses as a tax-saving strategy.  When there’s a major move in the markets, it can be a great time to rebalance.  Your goal may have been a portfolio that is 70% stocks and 30% bonds.  In a normal recession, it would be common for stocks to go down and bonds to go up. So now, your portfolio is more like 60% stocks and 40% bonds.  If you sell the bonds at a profit, you get to buy more of those stocks on sale to get back to that 70/30 mix, and you are better positioned to profit when the market rebounds. 

Convert to Roth

Lastly, if you expect to be in a higher tax bracket in the future, a recession can be a great time to convert your existing pre-tax, AKA traditional retirement funds, to a Roth.  When you convert pre-tax to Roth, you have to pay taxes on the money that hasn’t been taxed yet, so all of it in this case.  The idea is that if your $25,000 rollover IRA is now down to $20,000, you just got the long-term benefits of tax free growth in a Roth IRA, but you paid taxes on $5,000 less income to make it happen! 

Difficult or uncertain economic times are always scary. However, following these steps can relieve stress and anxiety and maybe even make this an opportunity to create brighter days ahead.