With the Great Recession a decade behind you, it may be hard or even painful to imagine that you could have to face another one. While the stock market has recently a hit an all-time high, employment is at record levels, and real estate prices are higher than ever before, it's important to remember that the economy always goes through cycles. In fact, some economists believe that a recession may loom as early as next year.
As hard as it may be to tell with any certainty when a recession may come, it's important to stay prepared, especially when times are good.
Here are several steps you can take to prepare for the inevitable next recession.
Create an emergency fund
While it may be unpleasant to think about losing your job, it's known to happen in a recession. You need a sizable emergency fund set aside. Your fund is supposed to cover you in the event of a job loss or other unexpected problem, and see you through several months when you pull in no income. In general, a fund large enough to cover six months’ worth of expenditures is considered standard.
While you may receive a severance package if you are laid off, the emergency fund is still an important cushion.
Update your resume and network
Even if you feel secure in your employment, virtually any position is vulnerable in a recession. Be sure to keep an updated resume that can be customized to highlight certain strengths for particular positions. Keep in touch with friends, mentors, and competitors in your industry to remain abreast of potential employment opportunities. In addition to building friendships, networking can be a life-long investment.
Examine your spending
If you don’t already have an emergency fund, building one can mean sacrifice. And even if you do, you may still need to look closely at what you spend during a recession. Not only will you likely have to make a budget, you may need to make tough spending decisions in order to set aside as much as you can. There are countless free budgeting tools available. Get one and track your spending. Then, eliminate those expenditures you can do without (you will likely be surprised at how much you can do without).
Pay off all the debt you can
Since paying off debt can be difficult in a recession, it's important to do it when times are good. You may be able to consolidate different credit cards into a single interest-free or low-rate credit card, which may help to pay them off more quickly.
In general, people tend to follow one of two different methods to pay off debt.
The first is called the debt ladder method. With this method, you prioritize paying off debt that comes with the highest rate of interest, first. Everything else gets minimal payment until the priority debt gets paid off. Once it is done with, you move on to paying off the loan with the next highest rate of interest.
The second method is called the debt snowball method. In this method, you pay off your smallest debts first, until you are only left with the big ones to focus on.
Look closely at your investment risk
Since stock markets and property values fall in a recession, it's important to make sure that you don't carry too much risk in your investments. If you're considering retirement in the next five years or you face particularly high expenses such as a wedding or college tuition, you may want to reallocate your assets by taking money out of riskier areas and put them into safer, more liquid ones.
Whether you have investments in business or in real estate, it's important to consult with your broker or financial advisor well before your assets drop in value so you are not forced to liquidate at the bottom.
Keep yourself abreast of the economic news
While depending on the wisdom of financial advisors can be a good idea, it can also be useful to learn something on your own about how to gauge economic news. As an example, there are economic indicators that are frequently in the news prior to a recession.
An inverted yield curve is one such indicator that has been flashing a red warning light recently. In a regular economy, the yield curve for investments shows short-term investments such as two-year Treasury bonds at low interest rates, and long-term investments such as ten-year Treasury bonds at higher interest rates. In an economy leading up to a recession, however, these interest rate levels often flip to show what is known as an inverted yield curve -- short-term investments come with higher interest rates than long-term investments. When you see news reports of consistent inverted yield curves you should be on alert that a recession may be looming.
Other likely predictors of a recession include a decline in corporate profits, a consistent rise in unemployment, a fall in housing starts, or a downturn in the index of leading economic indicators. A decline in one or two indicators may be meaningless, but when several of them turn down at the same time, pay attention. Plus, you do not need to be an economist to determine the trend in these indicators -- just pay attention to the business news.
Don’t wait till the last minute
Economies, markets and companies move in cycles. It is never a good idea to expect the good or bad times to continue indefinitely. Look for the warning signs and always be prepared.