How to prepare for a recession?

No matter who you are or what you do, a recession can have a serious impact on your wealth – and with the fallout from Covid-19, a global economic turndown may be (previously seem) looming closer than ever before.

Lara Maloney

Lara Maloney

17 June 2022

But you don’t have to simply sit, worry and wait for the bear trap to snap closed. There are plenty of things you can do right now to ride the waves of a recession – and possibly even come out the other side better off than when you started.

Here’s what you need to know:

1) Evaluate your current circumstances

Recession-proofing your finances starts with understanding your current situation, needs and overall financial health. This will provide the foundation you need to plan for the future.

To begin, start with the basics. Review how much income you have coming in and how much you’re spending.

Income may include:

  • Salary from you, your partner and any other contributing household members
  • Self-employment income
  • Rental income from property investments
  • Cash payments from dividends
  • Business income
  • Child support payments and similar

Spending includes all expenditure, but you should also take the time to consider your essential spending as opposed to your discretionary spending i.e. needs vs wants. Everybody’s wants and needs are different, but there are a few consistent categories for necessities:

  • Groceries
  • Utilities
  • Rent or mortgage payments
  • Debt repayments
  • Transportation and maintenance
  • Childcare
  • Medical care and prescriptions

You may also include things that are grey areas, such as gym memberships. For some people, this is an essential part of their physical and mental health. For others, cheaper or free alternatives will work instead. It’s up to you to decide. Ensure that you also consider upcoming major expenses as well, such as a wedding, holiday, property purchase or similar.

Add up all of your monthly expenses and compare it to your monthly income. You’ll discover whether you’re spending more, less or roughly the same as how much you’re earning. If you’re spending more or the same as you earn, it’s time to revisit those non-essential expenses and see what you can do to cut them down to size.

This type of budgeting is essential to ensure that you have income freed up to prepare more easily for a recession, such as fattening up your emergency reserves – more on that later.

Pro-tip: There will be some variability in your budget, such as utility bills that are different every time you pay them, so you won’t be able to calculate a precise and perfect number.

Instead, calculate a range of different scenarios, including the absolute bare minimum you could spend to get by if you lost an income stream (such as a job). A recession doesn’t necessarily mean you have to cut all your spending, but it’s useful to have a few options for different scenarios.

What if I want or need to increase my income?

If cutting expenses doesn’t work for you, then you’ll need to increase your income ahead of the recession. Consider how you can build up your income streams through freelance work or passive income opportunities.

Consultancy work, side hustles or part-time weekend work are all great options. It’s easier than ever to work from home in your free time and build up your income reserves, no matter where you are in New Zealand.

2) Build your emergency fund

Emergency funds are cash reserves designed to cover your expenses for 3, 6 or 12 months. The idea is that, should you lose part or all of your household income, you will still have several months’ worth of cash to cover the gap while you find a new job or additional revenue stream.

Emergency funds are especially important to have during a recession. Over a recession, people often lose jobs, businesses close, and many investments suffer downturns. This all has an impact on your income, and without an emergency fund, you may need to delay your financial goals or even take on non-productive debt to cover essentials.

Thankfully, building an emergency fund is easy. You don’t have to do anything special; simply open a new savings account at your preferred institution and contribute to your emergency fund with every paycheck. Once you hit 6 months of expenses covered (or better, 9 or 12 months), you can just sit on your fund until you need it.

How much will I need in my emergency fund?

We recommend a minimum of 6 months and a maximum of 12 months of expenses for your emergency fund. You can use the expenditure you calculated in the previous section to determine exactly how much you spend over 6 months and thus how much you’ll need to save.

What if I already have an emergency fund?

If you already have an emergency fund, it’s a good idea to plump it up a little ahead of a recession. If you have 3 months covered, try to save for 6 months. If you have 6 months, try to increase it to 12 months’ coverage. Depending on your role, recessions can mean it takes longer to find a new job. It’s better to be over prepared than underprepared.

What if I have income protection insurance?

If you have income protection insurance, that’s great! That will help cover your expenses until you find work. However, depending on your policy, you may find that it doesn’t pay out enough to cover everything. At MyFuture, we’re accredited for providing insurance advisory as well!

That’s why it’s still a good idea to have an emergency fund, even if you have income protection insurance. Some insurance policies explicitly don’t cover redundancies due to recessions so it’s important to check the fine print – or better yet, discuss this further with your insurance broker.

3) Prioritise debt repayments

Ideally, preparing for a recession means that you will be able to cover all of your debts even if you lose all sources of income (see emergency fund above). However, sometimes even the best laid plans don’t work out, so you’ll need to prepare for if things go awry.

Part of that is prioritising your debt repayments. If you have outstanding missed payments, pay them ASAP. If you owe money on credit cards, pay them off, starting with the one with the highest interest. If you have car loans or personal loans, see if you can get your account into credit.

Debt can be a useful way to build your finances (such as using a home loan to invest in a rental property). But during times of recession, any debt that isn’t actively growing your wealth is a liability.

Debt consolidation may also be a good idea, where you roll credit cards, car loans and personal loans into a single repayment, usually at a lower interest rate. This will reduce the pressure by simplifying your debts and, more importantly, reducing how much you’re spending overall. The sooner you do this, the better, as it will become harder to get approval for any kind of finance, debt consolidation included, if you lose your job.

Be careful with debt consolidation though. Some loans come with break fees or early repayment fees (such as if you’re refinancing a fixed-rate home loan). These breaks fees can be expensive and potentially cost you more than they save – speak with a finance adviser such as MyFuture to do the calculations accurately and find alternatives for your debt consolidation.

What if I’m going to miss a debt payment?

Missing a debt payment isn’t the end of the world, but it isn’t ideal. Not only does it cost you penalty fees and/or interest, but it also damages your credit score. Missing too many payments could result in your home, car or other security being seized, which may in turn reduce your ability to earn and make it even harder to pay your other debts.

It’s not a cycle you want to get caught in, especially during a recession.

If you are facing a missed payment, there will be several options in front of you. You can speak with your lender about applying for hardship or a deferral. You still have to make the payments eventually (and with additional interest), but they are pushed into the future when the recession may be less severe and your income has recovered.

A lender will often be open to organising a payment plan that fits a reduced income too. Lenders want you to be able to make your payments, even if they are smaller than expected, so you may be surprised at how flexible they can be.

The key is not to be afraid of communicating with your lender(s) if you’re going to miss a repayment!

4) Reduce your investment risk

Here’s a hard truth: your investments are likely going to take a hit over the course of a recession. But not every portfolio is hit the same way: a well-diversified, recently reviewed set of assets is likely going to perform better than the less-diversified, set-and-forget equivalent.

You can’t make your portfolio completely recession-proof, but you can trim your risk and ensure that it matches your investor profile. If you’re going to need a chunk of cash soon (such as for a deposit on a house) and can’t wait for the recovery after the recession, it may be wise to cash out some of your more volatile stocks and shares, for example. A professional financial adviser will be able to guide you with personalised advice.

This is also a great time to revisit the balance of your portfolio. Every smart investor ensures they don’t keep all their eggs in one basket, and that’s even more important over a recession. Ideally, you’ll have a good mix of different investment vehicles, such as cash, fixed interest, property, shares and so on.

A diverse portfolio means that, should a particular industry, location or asset class take a hit over the recession, you’ll have others that are less impacted (or may even profit), so your financial goals stay on track.

Pro-tip: Shares almost instantly respond to even the slightest hint of a recession, and waiting for the tsunami to hit to rebalance your portfolio could simply lock in your losses. Our advice? Maintain a well-diversified portfolio that matches your risk profile ahead of any possible recession.

Remember that generally speaking, when dealing with a well diversified, fundamentally sound portfolio, your investments are the most profitable when they’re left untouched. Panic-selling is a great way to solidify any losses you’ve experienced, while staying firm to your investment timeline will help ensure that any dips remain temporary.

5) Invest in yourself

During a recession, it’s imperative to either a) retain your current job and/or b) be able to find a new job easily. To do either, it’s best to brush up on your skills and invest in yourself.

A few options to pursue or investigate now may be:

  • Getting additional training or tertiary education to update, upgrade or expand your skill set.
  • Begin working towards a recession-resistant industry or career (healthcare is a common one).
  • Grow your revenue and skills through freelance work.
  • Increase your finance knowledge to make better money decisions with the help of an advisor.

Generally, you want to make yourself as attractive as possible to current and potential employers, whether that means growing your skills or taking on additional responsibilities. If your workplace is struggling through a recession, you’re going to want to be indispensable.

Looming recessions can be draining, but you don’t have to let money worries add to your stress. We can help you get on top of your finances and prepare properly for an economic downturn. Book in your free Discovery Session with one of our Qualified Financial Advisers today.