Recession or Depression: It is pertinent to know that there is the possibility of the economy of any nation to be characterized by periods of rising followed by recession or depression. While this to a large extent is unavoidable, you should understand how to prepare for them.
Dealing with a recession or depression is almost inevitable in a given lifetime. Someone who is truly financially healthy, however, will make sure they have a plan in place to handle those setbacks.
If you have not prepared for a recession then you should. You may be wondering how to go about this preparation; this article will provide you with all the necessary information you may need. However, first understand what recession is.
What is a Recession?
In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock).
This may be triggered by various events, such as a financial crisis, an external trade shock, an adverse supply shock or the bursting of an economic bubble. In the United Kingdom, it is defined as a negative economic growth for two consecutive quarters.
In the United States, it is defined as a significant decline in economic activity spread across the market, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
Important Things to Remember When Preparing for Recession or Depression
Having a fully diversified portfolio can go a long way toward protecting you in case of a recession or other systematic risk. Rather than having all your financial eggs in one basket, make the effort to keep your investments across a wide variety of industries, types, and risk levels.
As you make your long-term financial plan, use an opportunity cost framework. That means measuring the options based upon the cost of giving up an opportunity.
Some Types of Recession or Depression
1. Boom and Bust Recession
Many recessions occur after a previous economic boom. In the economic boom, economic growth is well above the long run trend rate of growth; this rapid growth causes inflation, and a current account deficit and the growth tends to be unsustainable.
When the government / Central Bank see that inflation is getting out of control, they respond by implementing tight monetary policy (higher interest rates) and tight fiscal policy (higher taxes and lower government spending).
Also, an economic boom is often unsustainable, e.g. firms may be able to temporarily produce more by paying workers to do overtime, but this might not last. In a boom, consumer confidence tends to soar.
- Can often be short-lived.
- If caused by high-interest rates, reversing rate increases can cause the economy to recover.
- Can be avoided by keeping growth close to long-run trend rate and inflation low.
2. Balance sheet recession
A balance sheet recession occurs when banks and firms see a large decline in their balance sheets due to falling asset prices and bad loans. Because of large losses, they need to restrict bank lending, leading to a fall in investment spending and economic growth.
A depression is a prolonged and deep recession, where output falls by over 10% and very high rates of unemployment. A balance sheet recession is more likely to cause a depression because falling asset prices and bank losses have a long-lasting impact on economic activity.
4. Supply-side shock recession
A very rapid rise in oil prices could cause a recession due to the decline in living standards. In 1973, the world was highly dependent on oil. The tripling in the oil price caused a sharp fall in disposable income and also caused lost output due to lack of oil.
How to Prepare for a Recession or Depression
Invest in Assets That Are Guaranteed to Nominally Increase in Value
When considering how to diversify your portfolio, consider investing in something that will not lose money—and may even increase slightly. Some of these include bank accounts, savings bonds, and other similar vehicles for your money.
Update Your Resume
You should always have an up-to-date resume just in case, but if you see a recession coming, that resume is even more important and can get you hired fast if you lose your job as a result of an economic downturn.
Get your debt paid off as quickly as possible, including credit cards, personal loans, and even student loans. The less debt you have if a recession hits, the fewer obligations you’ll still have to be making in the face of a job loss, salary downgrade, or other financial hit.
It may mean cutting back on a hobby, maybe dining out less, or curbing other spending, but you’ll be in a much better financial position if there is a negative financial event.
Improve Your Credit Score
Your credit report has much to do with how many opportunities are open to you. That can become critical in a recession, when you may need to find a new job or take out a loan of some kind.
Even if you find yourself needing to sell your home and move into a smaller apartment, your credit report can either help get you there or stand in your way.
You can keep track of your credit score for free with smart phone apps or by getting a free copy of your report once a year to ensure there are no errors or items that need to be disputed.
Keep Track of Your Expenses
Budgeting is not just for people who are short on cash; in fact, it’s how many people who are financially secure got that way. If you are holding yourself accountable each month for purchases that could have been avoided or done differently, you’ll be ahead of the game—and managing your money wisely.
Make All Risky Investments Assuming That a Recession is Coming
When you are looking to diversify your portfolio, go into it understanding that risky investments are considered that for a reason because the market can be fickle and recessions do come.
If you go into it with your eyes open, you will be prepared for loss, or perhaps you’ll even make less risky choices to begin with. Risk isn’t always a bad thing as it can come with high returns. But if you know a recession is coming, you may think twice about how much of your money you’re willing to put in those investment vehicles.
Develop a Plan of Attack in Advance
The next recession may be a year away, or it may be ten years away. Regardless of where the economy is in its cycle, however, planning for loss or recession is always a good idea. Even if the economy itself doesn’t take a dive, you’ll be well-prepared for any financial emergency you may encounter.
From the above therefore, it is apparent that recession and depressions is capable of damaging your financial health and cause problems far longer than you can imagine. Thus, preparing now will help you bullet proofing your finances in case the economy goes bad.
Never forget to take out time to pay down debt, check your credit rating, and put some cash aside for an emergency fund. You may not be able to predict every possible financial event, but you can prepare in a way that will set you up for success no matter what happens.