A recession can affect many parts of your financial life: your job, your budget, your savings, and even your plans for the future. While you can’t control the economy, you can take steps to prepare. Whether you're worried about job cuts, rising prices, economic uncertainty, or stock market swings, building smart money habits may help you feel prepared to navigate financial changes.
What Is a Recession?
A recession is a significant decline in economic activity that is spread across the economy. In the United States, the NBER considers the depth, diffusion and duration of a downturn when identifying recessions.1 It usually involves higher unemployment, lower consumer spending, and reduced business activity. These slowdowns are part of the normal economic cycle and can result from a variety of economic and financial shocks
How Economic Conditions Change During a Recession
Although recessions vary, certain economic conditions may occur before, during and after a downturn. Knowing these conditions may help you better understand what to expect.
Weakening Economic Activity
Before a recession starts, there are often signs that the economy is slowing down. These can include things like slowing employment growth, falling income or spending, declining industrial production and weakening GDP/GDI.1 Weakness in the job market, including slower hiring or layoffs, may also signal that economic conditions are changing.
Onset of the Downturn
Once a recession hits, the economy usually starts shrinking. GDP typically declines, unemployment rises, and businesses may cut back on spending or staff. People may also cut back on discretionary purchases, focusing instead on essentials.
Worsening Economic Conditions
As a recession progresses, unemployment may rise and credit conditions may tighten. Labor-market weakness can continue even after broader economic activity reaches its trough and begins to recover. Businesses and consumers may become more cautious about spending and investment, while financial markets may also experience heightened volatility. If market declines become prolonged and severe, investors may also experience a bear market.
Stabilization & Early Recovery
Eventually, the economic slowdown begins to ease up, and small signs of recovery start to appear. You might see more people getting hired or spending a little more money, and some industries slowly begin to bounce back. To help things along, the Federal Reserve may adjust interest rates or use other policy tools in response to changing inflation, employment and economic conditions.
Continued Recovery & Expansion
The recession ends at the trough, after which a new economic expansion begins. Employment, household finances and other measures may take longer to fully recover, but people start to feel more confident, and businesses slowly start to grow. For many families, this can be a good time to rebuild savings and think about future plans.
Economic Indicators to Watch
There are a few key indicators that may signal a recession is happening or on the way. These include:
- Falling Gross Domestic Product (GDP): This means the economy is slowing down, with less spending and production.
- More Unemployment: When companies lay people off or stop hiring, unemployment rates go up.
- Stock Market Drops: Big or steady declines in the market can show that investors are worried. Stock-market declines may reflect investor concerns about future growth, but a correction or bear market can occur without an economic recession.
- Tighter Financial Conditions: Higher borrowing costs can slow interest-sensitive spending and investment, but higher interest rates alone do not mean the economy is in recession.
Steps to Prepare for a Recession
1. Build an Emergency Fund
Try to save enough money to cover basic expenses in a savings account you can easily reach. The appropriate amount depends on factors such as job stability, household income sources and monthly obligations, but 3 to 6 months of expenses in an emergency fund is a good starting point. This can help if something unexpected happens, like losing your job or getting a big medical bill. Having extra cash saved up may keep you from needing to use credit cards or dip into retirement savings when money gets tight.
2. Evaluate & Adjust Your Budget
Regularly reviewing your monthly spending can help you identify non-essential expenses like streaming services, dining out, or entertainment. In uncertain times, it may make sense to focus more on essentials like rent, food, healthcare, and utilities. If you own a home, be sure to account for mortgage payments, property-related expenses and other essential housing costs. Setting up a simple “bare-bones” budget and using a budgeting app can make it easier to manage your money and stay in control.
3. Manage & Reduce High-Interest Debt
If you have high-interest debt, like credit cards or balances from high-interest personal loans, it might help to look into options like refinancing or debt consolidation. These can sometimes lower your interest rate, reduce your monthly payments, and make your debt easier to manage, especially during tough economic times. Compare the APR, fees, repayment term and total cost, not just the monthly payment. A lower payment may result from extending the repayment period and could increase your total cost.
Paying bills on time and reducing revolving balances may help strengthen factors used in credit scoring, although the effect on your score depends on your overall credit profile and scoring model.
A consistent debt management strategy can also help you prioritize which balances to address first while preserving room in your budget for essential expenses and savings.
4. Consider Asset Allocation
Spreading out your investments can help lower your risk during uncertain times. When your money is in different types of assets, a drop in one area may be balanced out by gains or stability in another. Building a diversified portfolio based on your goals, time horizon and risk tolerance may help reduce your exposure to any single type of investment.
This kind of mix can be especially useful during ups and downs in the market, since some investments tend to do better than others depending on the economy. For example, you might include a mix of:
- Mutual funds and exchange-traded funds (ETFs) that help provide diversified exposure, depending on their holdings and investment strategy
- Index funds designed to track a particular market index
- Bonds or bond funds, which may provide income and potentially lower volatility than stocks but still carry interest-rate, credit and market risk
- Cash and cash equivalents for liquidity
All investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results. Neither diversification nor asset allocation ensure a profit or protect against loss in a declining market.
5. Protect Your Credit Score & Bank Accounts
It's important to regularly check your credit reports for errors that could affect your score. Catching and correcting inaccuracies early may help you avoid issues when applying for credit during uncertain times. Making on-time payments, even if you're only able to pay the minimum, can also play a key role in maintaining a strong credit rating.
In addition, confirm that your bank accounts are FDIC-insured; this protection generally covers eligible deposits up to $250,000 per depositor, per FDIC-insured bank, for each account ownership category, and can help protect eligible deposits if an FDIC-insured bank fails.2
6. Explore Additional Income Opportunities
To give yourself more financial stability during a recession, it may help to look for ways to earn money from more than one source. You could try freelance work, start a small side business, or even turn a hobby into extra income.
Developing marketable skills may also broaden your employment options if your current role or industry is affected. Having multiple income streams may make it easier to get through tough stretches if your main job is affected or conditions in the job market become more challenging.
Common Mistakes to Avoid During a Recession
Making Major Unplanned Purchases
Big-ticket items like cars, appliances, or renovations can strain your finances during uncertain times. Consider postponing major discretionary purchases if they would significantly reduce your emergency reserves or require adding debt you may have difficulty repaying.
Overreacting to Market Volatility
Panic-selling investments during a downturn can disrupt your long-term strategy. A market correction, bear market, or other period of volatility can be unsettling, but reacting emotionally may undermine a long-term investment plan.
Relying Too Heavily on Credit
Using credit cards to cover basic expenses may lead to rising debt and interest payments. Without a plan to pay off balances, this can become difficult to manage, especially if income is reduced. The same may be true of relying on personal loans or other forms of borrowing to fund ongoing living expenses.
Draining Your Retirement Account Early
Tapping into your retirement account to cover short-term needs may trigger taxes, penalties and lost long-term growth potential. Before taking an early distribution, compare its taxes, potential penalties and loss of future tax-advantaged growth with your other available options.
Making Financial Decisions Without the Full Picture
When money’s tight, it might seem easier to sell investments impulsively or allow important insurance coverage to lapse. But quick decisions like these can have long-term effects. Taking a step back to look at your full financial picture may help you stay on track through economic uncertainty and changing market conditions.
Conclusion
While no one can say exactly when a recession will happen, being prepared can help you feel more secure. Small, steady steps like saving, budgeting, debt management and maintaining a diversified portfolio may offer more control, even in uncertain times. And if you're unsure what to do next, talking to a financial professional may help you explore options that fit your situation.
Sources
- Business Cycle Dating. https://www.nber.org/research/business-cycle-dating
- Understanding Deposit Insurance. https://www.fdic.gov/resources/deposit-insurance/understanding-deposit-insurance
