A recession is one of the harshest realities for the majority of modern Americans. Although recessions have been a natural part of the American economy throughout history. It is important to have an effective financial plan in place, to ensure protection against potential risks.
What causes a recession in an economy?
Before we jump into the top ten best ways to prepare for a recession, let's first review the basic mechanism that causes recessions.
1. Lose of consumer confidence:
Consumers are the primary driving force behind the economy. When they decide to tighten their wallets and stop spending money, that causes companies to lose revenue and eventually lay off employees. This causes a chain of events that will ensure the recession continues and deepen.
2. High-interest rates:
The price of money and credit is an essential factor in any thriving economy. When the interest rates become too high, not many people can afford to pay for their homes or buy cars or anything else that requires a loan. That means less consumption of goods, which can cause a recession.
3. Asset bubbles:
The rapid rise of prices for real estate, stocks, and bonds can be a cause of concern. The moment when prices start to fall is the moment when the recession becomes imminent. It causes a domino effect that can lead to all types of other financial problems as well.
4. Economic shocks:
Political turmoil, social instability, and wars can cause a recession as well. If America decides to enter another war, for example, that will have a huge impact on the economy as a whole. The same is true if any other country causes an economic shock with their actions.
5. High inflation:
The high rate of inflation causes a lack of purchasing power among people. Nowadays, inflation is less of a problem because economies around the world have been struggling to keep prices from rising. That being said, anything that causes inflation can still cause a recession if it gets out of control.
These are some of the main reasons why a recession may happen. There are, of course, other reasons why recessions can occur, and these five seem to be the most common ones.
How to protect yourself from a financial crisis:
Once you understand the reasons why a recession is likely to occur, it becomes easier to figure out how you can prepare your finances to withstand the worst effects of an economic crisis. The following are some tips on how to prepare for a recession:
1. Prepare an emergency fund:
This is the most important tip when it comes to protecting your finances in case of a recession. You need to have enough money to avoid taking on new debts during times of crisis. If you are not sure how much money should be in your emergency fund, there are plenty of tools online that can help you calculate your ideal amount. Ideally, you should save at least 6 months of income to be protected.
2. Get your finances under control:
To get your finances under control, make sure that you aren't losing money due to unnecessary expenses. Start by making a budget and examining how you can reduce your spending. If you manage to reduce unnecessary costs, that will allow you to put more money into savings in case the worst happens.
3. Get rid of unnecessary debts:
Take a look at all your monthly payments and make sure they fit within the limitations of your current budget. If there's any debt you can get rid of, do it. This may require sacrificing some luxury purchases, but that's a small price to pay to ensure your finances are stable even in times of crisis.
4. Diversify your investment portfolio:
There are plenty of ways to invest money. In times of crisis, certain types of investments tend to be more profitable than others. At this time, it's a good idea to focus on safe investments such as bonds and treasury bills. If you have enough savings for retirement, it may make sense to invest in your IRA or 401(k).
5. Create multiple income streams:
Relying on a single income source is one of the biggest mistakes many people make. Create multiple income sources so that if one of your investments starts performing poorly, you still have other ones to depend on. This applies not only to jobs but also to side gigs as well. Having a secondary source of income can be crucial in case you lose your day job.
6. Find recession-free jobs:
The economy is constantly changing. As a result, certain industries grow while others shrink. Look for recession-free jobs to prepare yourself for the worst-case scenario. Industries that are less likely to get affected by an economic crisis include healthcare, IT, consumer goods, and energy (if you don't invest in oil).
7. Create a budget:
Creating a budget is one of the best ways to get your finances under control during a recession. As mentioned earlier, start by examining your monthly costs and seeing how you can reduce them. Once you have a better idea of how much money you're spending on various things, create a realistic budget based on that amount.
8. Live below your means:
The best thing you can do to prepare for a recession is to live below your means. Doing this will allow you to put more money into savings, which will serve as an emergency fund in case of a crisis. Make sure that all your expenses are covered by the amount of money you're making and don't go beyond that point.
9. Learn more skills:
In case the economic crisis turns into a full-blown recession, companies will have no choice but to downsize their workforce. If you know certain skills that are in high demand, it would be a good idea to start learning about them ahead of time so that if layoffs occur, you will be able to put yourself in a better position than others.
10. Take care of your health:
During a crisis, many people will ignore their physical well-being to put more money into savings or pay off debts. However, this is a mistake because if you don't take care of yourself, there's a chance that you won't be able to work when the economy starts recovering. As such, maintaining your physical and mental health should be a top priority during times of economic crisis.
This was a quick rundown of the top ten ways to prepare for an recession. If you follow these tips, you will put yourself in a much better position to deal with the aftermath of another recession. While nobody knows what the future holds, it never hurts to be prepared for potential threats that may come your way.