Hearing words like high inflation, bear market, and recession bandied about in the financial news is nerve-wracking. It would be natural for you to worry about how this will affect you and your family. We’ll explain these terms and how to prepare for a recession.
Even if a recession is not forthcoming, it’s always a good idea to understand how the macro factors may affect your finances. Recessions appear periodically and may be mild and short in duration, like in 2020, or moderate to severe, like the Great Recession, which lasted 18 months. While we typically don’t know if and when a recession will come, keeping your finances in good order and having liquidity is the best preparation always and reduces stress about the unknowable. You can control your household economy, not the macroenvironment.
What Is Happening In Our Economy: Inflation, Bear Market, and Recession?
Inflation Is Raging
Inflation is a steady rise in the prices of goods and services purchased for consumption for urban households measured monthly by the consumer price index (CPI).
Consumers are paying higher prices at the gas pump, grocery stores, and elsewhere. After years of low inflation, inflation rose in 2021 to higher levels above the target 2% rate. High inflation persists, with an 8.2% inflation rate in September 2022, despite the Federal Reserve’s efforts to slow the economy.
Consumers need to prepare for higher interest rates. The last time the Fed faced pressure was in the late 1970s-1980s when inflation soared to 14.8%, and the Fed raised its fed funds rates to an all-time high of 20%. No one believes we will revisit those extreme times.
The Bear Market Is Here
The stock market declined 21% from its January 3, 2022 peak, essentially causing a bear market, as it reacted to the Fed’s failure thus far to tame the inflation and anticipated higher interest rates. A bear market is a market in which securities prices have declined in value by 20% or more from previous highs for weeks or months. We have had 14 bear markets, including the current one) since 1947. The average length of a bear market is around 9.5 months, and they last 3.5 years apart from each other.
Bear markets often make way for buying opportunities when they clear the decks by driving down valuations to low levels from which more significant gains can occur. The challenge for investors is timing the bottom, which I don’t recommend and will discuss later.
A Looming Recession?
A recession accompanies most bear markets but not always. A recession is a temporary economic decline with weaker trade, unemployment, and industrial activity, generally identified by a fall in GDP in two successive quarters. They usually last from six months to a year (averaging 11 months), marked by contractions in many sectors of the economy. In five of the past six recessions in the last half of the century, bear markets attended recessions 83% of the time.
With rising inflation, consumers are spending more for less, paying $4 per gallon of gas and groceries. Many hope that the Fed’s efforts to raise interest rates to slow down the economy will result in a “soft landing,” but there are signs of a recession looming if it is not already here.
In the first quarter of 2022, GDP declined at a 1.5% annual rate. GDP fell further in the second quarter when the BEA issued its report, confirming a technical recession. Another sign is the direction of unemployment. Thus far, unemployment remains low at 3.5% in December, but some companies have announced layoffs, and if it becomes a trend, then unemployment will rise.
7 Ways: How To Prepare For A Recession
It is not fun to see your retirement and investment accounts as the market decline, with some sectors down more than 30%. Hang in there. You can’t control what happens in the stock market and our economy, but you can change your lifestyle, reduce debt, save more, spend less, and avoid knee-jerk investments by selling out of panic.
Review Your Budget
It is essential to review your budget, spending, debt levels, and ways to reduce spending to save more. When inflation is high, it is more challenging to reduce spending because the cost of your goods is higher than the 2% target. The potential of a recession may mean losing a job if you work in an industry susceptible to economic downturns. If so, tightening your budget and living stingy may be in order.
Reduce Your Debt As Interest Rates Rise
The Fed’s efforts to raise interest rates lift most consumer and business borrowing rates, including mortgage, auto, student, and credit cards. That may mean you should postpone plans like buying a home with 30-year fixed mortgage loans over 7% unless you find something special.
You’ll need to continue to pay off your debt on time, avoiding late charges. Consider options depending on your finances and debt situation.
After having a hiatus from paying off loans during the pandemic, students will need to pay their federal student payments. Additionally, these rates for the 2022-2023 academic year rose to 4.99%, up from 3.73% last year and 2.75% the year before. Private student loans will increase too.
A recent survey found that 92% of fully employed student loan borrowers are worried that rising costs will make it harder to afford their payments, and one in three borrowers will need to cut back on necessities–food, rent, and healthcare–to be able to make payments.
Eliminate Credit Card Balances
Eliminate those toxic card balances that grow faster than your income. Carrying credit card balances is treacherous, especially when interest rates are climbing above already high rates. There are a few options: balance transfer credit card, debt snowball, or avalanche method, or get a debt consolidation loan.
If you have at least a FICO credit score of 670, you should consider getting a balance transfer, a type of credit card that allows you to move your card balance to another card with a 0% APR for a time, but there may be fees.
Snowball or avalanche methods may take time to pay off your balance. The avalanche method is more appropriate for large card balances as it targets higher costs first. A debt consolidation plan may be another option, allowing you to move your debt, including the card balance, to a personal loan. While you won’t get the 0% APR, personal loans should offer lower rates than that charged by credit card issuers.
Reduce Spending, Especially For Discretionary Spending
Review your budget, looking for ways to save more and reduce unnecessary discretionary spending. Look for low-hanging fruit to cut out spending:
- Reduce subscriptions you aren’t using.
- Go shopping with a list and stick to it.
- Shop for bargains for things you need.
- Using shopping apps and coupons.
- Eat out less, make meals at home, and grill more.
- Enjoy the outdoors, and find free and inexpensive activities.
- Add a passive income stream to put extra money in your wallet.
Boost Your Emergency Savings Account
By realizing extra savings, boost your emergency cushion, primarily if you work for an industry or business prone to recessions. As interest rates rise, you can get a higher-yielding saving account at the bank for your emergency fund. Recessions typically have higher unemployment than the current 3.7%.
When inflation was high in the 1980s, it was an excellent time to put extra cash into these accounts. My mom told me she received two TVs and 13% APR on her savings account. Just make sure you understand if the account has any withdrawal restrictions so that you can access your money when you need the money.
Persistent Contribution To Retirement Accounts
It is essential to continue contributing to your 401K and Roth IRA or traditional IRA retirement accounts. If your employer matches your contribution, you’ll want to earn it based on the plan. Seeing the 20%-30% decline in your account balances is undoubtedly painful, but these are unrealized, or paper losses, and your retirement may be years away. With the market downturn, you’ll be able to buy stocks at or near bargain levels. Remain diversified with index funds.
There are significantly more challenges for those at or near retirement age and planning to retire soon. It may be an excellent time to speak with a financial advisor to consider options that evaluate taking social security earlier or taking some money from your retirement accounts if you need extra income due to the high inflation.
Investing In A Bear Market
Investing in the best of times can be emotional. Watching your holdings drop in value can paralyze experienced investors. Corrections and bear markets are regular occurrences. It is best to avoid being overly emotional about short-term losses.
Some things to do when investing:
Investors can prepare for potential downturns by holding some cash for potential buying opportunities, though timing your purchases are the challenge.
Don’t time the market. It has yet to be determined whether this is the bottom or to expect further declines in the market.
A viable alternative to timing the market is using dollar-cost-averaging, ensuring investment discipline. It is a systematic strategy for investing equal sums at regular intervals regardless of the investment’s price. This approach removes the guesswork of timing your purchases. Instead, you are investing the same fixed dollar amount in the same stock, mutual fund, or ETF over a long time. The strategic premise is that investments generally rise more than they fall. By averaging, you purchase more shares when the price is down or below average costs.
When you’re a Buy/Hold investor, you keep a long-term perspective on the economy and the market.
In market downturns, it may be challenging to buy individual stocks unless you do some research. Look for leading quality companies with track records of performing well in recessions in more resilient industries, strong balance sheets, and continued dividend growth. You can purchase recession-proof stocks or dividend aristocrat stocks for your portfolio.
If you have some cash and seek safety and high returns, there are no better places to go than investing in Series I Government Savings Bonds that currently pay 6.84% in interest and with a AAA rating. There is a cap of $10,000 per person on the purchase amount, but you can buy a bond for each of your children. Alternatively, TIPS or Treasury Inflation-Protected bonds provide similar benefits without the cap.
Variable municipal bonds also have inflation protection for investors though they usually have higher risks than treasuries offset by better tax-exemption benefits for holders.
We may be heading into more challenging economic times. While you can’t control the macroenvironment, take care of your personal economy by getting your finances in better shape. Adjust your lifestyle to save more money and avoid making moves out of fear and panic.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.