5 Personal Finance Tips to Help You Weather a Brutal Recession

Webp.net resizeimage 2022 06 22T005352.415

The stock market and economy can’t always go up. It’s not what you do when times are good that matters, but what you do when times are tough. When it’s time for the market to correct and potentially enter into a recession, how are you planning to manage your money? Do you have a plan for how to weather the next economical storm?

If not, don’t worry. This post reveals five personal finance tips to remember during recessions that will help position you so that you can make it through to the other side. It might not completely get rid of the pain, but it may help to make it a bit more bearable.

What Exactly is a Recession?

Before getting into the various personal finance tips that could help in a recession, it’s helpful to first have a working definition of what a recession is. Of course, everybody knows that during a recession, the stock market goes down and people lose jobs, but these are often characteristics/symptoms of a recession. What is the actual cause of one, and what is a recession really?

Generally speaking, a recession occurs when an economy experiences slowing economic activity. Normally, the GDP (output) of a country is constantly growing, so the rule of thumb for a recession is two consecutive quarters of declining GDP.

A few of the reasons why a country might experience a recession are:

  • A sudden economic shock to the system – COVID-19 is an example of an unexpected shock to the world economy that sent lots of countries into a recession.
  • Bubbles – Asset bubbles like the tech bubble of the 1990s and the housing market bubble of the 2000s are great during the run-up, but when the bubble pops, it often leads to a serious downturn in economic activity.
  • Excessive inflation – Inflation is defined as the percentage by which prices for the same goods change over time. If inflation suddenly jumps higher one year

Some of the effects of a recession are:

  • A struggling economy – This is best reflected in the way that asset prices fall and the stock market becomes devalued.
  • Lower profits – Companies tend to make fewer sales during a recession and thus take in less profit.
  • Higher unemployment – On a similar line of logic, when a recession hits, companies often look for ways to save money, and one of the easiest ways to do that is to lay people off.

Five Personal Finance Tips to Help You Get Through a Recession

Now that we’ve covered what exactly a recession is, here are some of the best things to remind yourself of in the event you find yourself living in a recession.

Remember The Golden Rule of Investing

When a recession hits, oftentimes people start selling their positions. They do this because they fear that the stock market will drop even lower. This is a kind of self-fulfilling prophecy because when people sell stocks it lowers the demand for them and thus reduces the price. By selling the stock for fear that it will drop, you are actually contributing to its drop!

While selling off some stock positions when you think they are getting a little too overvalued is a fine thing to do, during a recession this is often not the reason why people sell. People usually sell during a recession when the value of the stock has already dropped quite low for fear that it will go even lower.

By doing so, many people break the one golden rule of investing: buy low and sell high. Buying low and selling high is the only way to earn capital gains on your stocks and when you sell off in a recession, you often sell for a lower price than what you bought a stock for.

Though fearing a market downturn is reasonable, there are a couple reasons why you should consider thinking twice before selling a stock:

  1. Fees – Oftentimes brokerages will charge a commission on every buy and sell of a stock. Even if you sell a stock and buy in at the same price point, it’s likely you’ll lose 1% – 2% on commissions immediately. Basically, you are selling a stock on uncertain information (a prediction that the stock market will continue to fall), and receiving a guaranteed loss regardless (the price you pay in fees).
  2. Uncertainty – It’s really hard to tell whether or not a stock market will continue to fall or whether it will bounce back. When you sell off a stock during a downturn, you need to be right twice in order to make money. You need to be right on the timing of the sale (you’ll need to sell when the market still has room to go down), and then you need to be right again on re-entry (you need to buy into the market right before it recovers). Getting the market right once is a task in and of itself. If you can do so consistently, you should definitely consider working for a hedge fund. Getting the market right twice in a row is something that is nearly impossible to do with any kind of repeatability.

Look at Historical Data

Do you ever get sick and think to yourself “this feels so awful that I will do whatever it takes to get well and stay well.” Then when you are well, you forget all about how bad the sickness felt and go right back to eating junk food and not exercising?

The human brain is weird in the sense that when times are going good, it’s easy to forget that bad times every existed and vice versa. This means that during a recession, it can often be tough to see the light at the end of the tunnel and hope is easily forgotten. For that reason, it helps to look at historical data and use some basic facts to help guide our thinking and calm our nerves.

It is a historical fact that every recession has corrected itself and eventually the economy has recovered. The only variables in these scenarios are how long it took for the recovery to happen and how volatile the recovery was. In the case of the 2008 housing crisis, it took a long time (years) for the economy and stock market to recover. For COVID-19 in 2020, however, it only took a matter of months for the market to jump back to its original levels.

However, regardless of the recession, the economy has always recovered. If you ever find yourself worrying about the future, remind yourself of this fact and know that even though it may be painful now, the future still looks bright.

Lower Entry Points = Higher Returns

On a similar line of thinking as the previous tip, if you’re young and have time on your side, you should rejoice during a recession as a market downturn allows you to pick up many assets for cheaper than you could in a bull market.

Not only that, but the effect is amplified for every percentage point that an asset drops. Let’s say a stock is $100, drops 10% to $90, and you decide to buy one. If the stock returns to its pre-drop levels of $100, your return isn’t 10%, but rather 11.11%!

The more assets you’re able to scoop up at lower entry points, the greater your potential return will be in the future!

Prioritize Paying Off Debt

If you’re really scared of the economy getting worse and are scared of tossing your money into a stock market that seems like it will decline further, there is an easy way to make immediate returns on your cash: pay off your debt.

Every dollar of debt you pay off now is one less dollar that could accumulate harmful interest that you’ll need to pay in the future. What this means is that if you have students loans with a 3% interest rate and decide to pay off $100 of student loans, you have instantly evaporated $3 of interest ($100 x 3%) that you would have had to pay in the future. In this sense, by paying off the debt you are earning an immediate return.

If you have lots of debt and also lots of cash sitting around that you don’t know what to do with, consider paying your debt off. It’s a lot easier to make personal finance decisions when you’re not weighed down by any debt and when you don’t need to make any monthly or annual interest payments.

Build an Emergency Fund

During a recession, it can be very helpful to have an emergency fund for a variety of reasons:

  1. If you lose your job, you can survive without taking on any debt by living off your emergency fund.
  2. If you find some seriously discounted assets, you can stock up on them with the added liquidity you have from your emergency fund.
  3. You will likely worry less if you have an emergency fund since you can rest easy knowing that you’ll be able to weather the storm financially regardless of what happens.

Though it’s great to have an emergency fund going into a recession, the next best thing is to start building one right away if you don’t have one already.

The general rule of thumb is that an emergency fund should be anywhere from 3-6x the size of your monthly salary. So if you’re making $4000 a month, aim for an emergency fund that’s $12,000 – $24,000 in size.

This size will allow you adequate time (in case you get laid off) to find a new job and will likely also cover an short-term emergency expenses you might have.

5 Personal Finance Tips to Help You Weather a Recession

Recessions are awful periods of time when economic activity runs low and businesses lay off people simply to stay afloat. They can seem scary if you don’t have an adequate plan or mindset in place.

That’s what this post is all about: providing you with a few tips and ideas to keep in mind so that you can better handle the next recession.

The tips / ideas listed in this post are

  1. Remember the golden rule of investing
  2. Look at historical
  3. Lower entry points = more potential profit
  4. Prioritize paying off debt
  5. Build an emergency fund

Hopefull these tips can keep you afloat for long enough that whatever recession you’re dealing with passes in due time. Happy investing!