How to Prepare for a Recession

According to Northwestern Mutual’s 2023 Planning & Progress Study, the majority of Americans (67 percent) believe the U.S. will enter a recession later this year. And of those expecting a recession, three-quarters say it will have a high or moderate impact on their short- and long-term finances.

Whether it’s the potential of a loss of income or some other financial impact, with uncertainty looming, it’s natural to be concerned about your financial situation. The good news is that there are steps that you can take to prepare for a recession and minimize the financial impact it can have on you.

“Periods of uncertainty provide opportunities to stress-test a financial strategy,” said Christian Mitchell, executive vice president and chief customer officer at Northwestern Mutual. “This is the kind of work our advisors do with clients every day. By planning for the inevitable bumps along the way, our advisors help our clients feel more confident that they’re on track to reach their goals, even in times like this.”

How to prepare your finances for a recession

While an economic slowdown will impact everyone differently, these five steps can help you prepare your finances so that you’re ready to weather whatever life throws your way.

1. Revisit your budget

Whether you do a great job keeping your spending on track or you’re just good at estimating it every month, this is the first place to start when there’s economic uncertainty. And according to the Planning & Progress Study, 64 percent of people are cutting costs to help offset the effects of a potential recession. The goal is to free up some additional money to save and to reduce expenses so that you’re ready in case you lose income in the coming months.

Start by tracking where your money is going—what’s coming in each month and what’s going out. Group your spending into three categories:

While it’s generally a good idea to save about 20 percent of your income, this may be a time when you want to push yourself to raise that percentage a bit and funnel the additional dollars toward your emergency fund.

But revisiting your budget shouldn’t make you feel that you have to deprive yourself. The goal here is to find some low-hanging fruit—perhaps subscriptions or memberships that you don’t use very often. You might be surprised how much you’re spending on things you hardly use or that don’t bring you joy. This is a good time to cut those out and put that money toward other goals, like savings.

Another possibility is to look for ways to make additional money. The gig economy can be a great way to earn some additional income to help prepare yourself for the potential of a recession. Doing so may also help you prepare in case you lose your primary employment.

2. Bolster your emergency fund

An emergency fund is one of the most basic components of any financial plan. An emergency fund is typically an account that’s separate from your main checking and savings or some other way to easily access cash quickly. This is money that you’ll use to keep yourself on track when something unexpected happens.

The uncertainty around a possible recession is exactly what this money is intended for. If you lose income, your emergency fund is how you’ll continue to make ends meet while you get back on track.

How much should I keep in an emergency fund?

While everyone’s situation is different, a good general rule is to keep about six months’ worth of expenses in an emergency fund. However, if you’re concerned about losing income, this might be a time when it’s better to have more than six months’ worth of expenses saved. That’s obviously easier said than done, but don’t sweat it too much. The key is just to start dedicating more to this account each month.

3. Consolidate debt and ensure access to credit

If you’ve been sitting on some high-interest debt (like a credit card), this may be a good time to look at getting your interest rate down. You can try calling your credit card company and simply asking for a lower rate. However, an even better option may be to open a new account with a 0 percent introductory rate (just watch out for balance transfer fees here). Other options could include using a home equity loan, which will usually offer lower rates than a credit card. Depending on the size of your debt, this can be a significant monthly savings.

At the same time, this may be a good time to ensure that you have access to additional funds if needed. While it’s best to use savings for an emergency, that’s not always possible. Some options could include:

Home equity line of credit (HELOC): A HELOC works a bit like a credit card in the sense that you’re approved up to a limit and can access funds as needed. But the loan is backed by your home, so it typically offers a much lower interest rate than a credit card. Even if you don’t need the money now, it might be a good idea to open up a HELOC to give yourself flexibility in the future. Just remember: Because it’s backed by your home, if you’re ever unable to repay the loan, you could lose your house.

Permanent life insurance: If you have a permanent life insurance policy that has built up cash value, this can be another option to access funds if you need them. You can take a loan from the insurance company against your cash value. Repayment terms are flexible, and getting the funds is typically quick and easy. Just keep in mind that, your death benefit will be reduced by the loan amount—and, if you don’t manage the loan, you could lose your policy and face a negative tax consequence.

Credit cards: While putting debt on a credit card is typically a last resort, if you suffer a financial setback and have no other means of accessing the funds you need to live day to day, this is an option to consider. Just make sure that you’re being careful about the amount you rack up here, as high interest rates can result in eventually owing significantly more than the amount you spent.

4. Stop watching the stock market

Stocks serve an important role in a financial plan by helping you grow your wealth over time. And while we all know the market doesn’t go up in a straight line, watching market swings can be emotional. It’s very common to want to make changes when stocks are losing value. But doing so can be costly.

To illustrate the point, consider a $100,000 investment in stocks that represent the annualized return of the S&P 500 over the past 20 years. Missing just the 10 best days of performance could cost you nearly $250,000 in gains. If you miss the 30 best days, you’d miss nearly all the growth you could have received over that period. The problem is that you never know when those “best days” will be.

It can be easy to want to make changes to your investments or maybe even access them to cover emergency expenses. But as the chart above shows, it can also be one of the most expensive long-term mistakes that you can make during uncertain times.

That’s the value of having a financial plan that goes beyond just investments. While they’re an important piece of planning, it’s critical to have access to other sources of funding to help you get through unexpected events. The different pieces of your plan (like your emergency fund) reinforce each other. By tapping your emergency fund rather than investments at a time like this, you set yourself up to achieve more growth over time.

5. Update or create your financial plan

Anyone can create a financial plan that will help in reaching goals if everything goes according to plan. The value a financial advisor brings to planning is by helping you create a plan that can stand up when life throws you a curveball. That’s why Northwestern Mutual financial advisors recommend strategies beyond just investments. By using a range of financial options that reinforce each other, a Northwestern Mutual financial plan can help you see how you’re on track to reach your goals and how you’re also prepared for bumps along the way, including a recession. That’s how a financial plan truly gives you confidence that you’re on track to reach your goals.

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