Preparing for a Recession in 2020
It’s a question on a lot of minds. When is the next recession? Although nobody can claim to possess the trillion dollar crystal ball that predicts recessions, extensive research has been done into what causes economic downturns and where the US seems to be in the current cycle.
It may seem as though there’s always an ongoing conversation about this, and it is overwhelming to try and decipher the mixed messages coming from politicians, economists, and the media.
Uncertainty and fear about the economy can lead to inaction and missed opportunities. There is a lot you can do to prepare and stay informed in the event of a recession.
What is a Recession?
The broadly used definition of a recession is when a country experiences two quarters of negative economic growth, most commonly measured using gross domestic product.
GDP is a measure of the market value of all goods and services produced in a period of time. When the GDP shows declining but still positive growth, this does not count as a recession. The percentage growth rate must actually be negative, indicating that the economy is shrinking.
The good news is that recessions don’t usually last very long, but even a few months can feel like forever if you lose your job, home, or business. According to the National Bureau of Economic Research (NBER) , the US has experienced 33 recessions since 1857. These have varied in length from six months to 65 months, but since 1945 they have averaged 11.1 months.
As you most likely remember, the most recent US recession was the Great Recession in 2008-2009. This was the worst recession since the Great Depression, with a total of five quarters of economic downturn—and was also the longest, lasting for 18 months.
What Causes a Recession?
The economy grows and contracts cyclically. Numerous domestic and international factors contribute to the timing of these cycles. While one can analyze data from past cycles and attempt to make predictions about the future, even the world’s foremost economists don’t often predict when the next recession will hit, and what will cause it.
This question even plagues Queen Elizabeth, who in the aftermath of the global financial crisis asked, “Why did no one see it coming?”
The world is always changing, and similar sets of circumstances don’t necessarily lead to the same result. New research is being done into how AI might be used to create better economic prediction models.
One of these models, the Intensity AI Forecast is already in use, and an updated recession forecast is posted every month. AI forecasting is still a very new technology, and shouldn’t be the sole source of information used to make significant financial decisions.
Various long term circumstances can lead up to an economic downturn, and often a shorter term ‘shock’ event is what incites a recession. Some of the factors that can contribute to a recession include:
Reduced Consumer Confidence
If consumers believe the economy is bad or heading toward a downturn, they might spend less money. Consumer confidence can change in response to political, international, and financial events.
Drop in Asset Prices
A financial crisis in the stock market can cause the failure or near failure of lending companies and banks, which grinds the economy to a halt. A market crash is often the result of a bubble, as we saw with the dot com stocks in the 1990s and the housing market in the 2000s.
The higher the rate of inflation, the fewer goods and services can be purchased with the same amount of money. When consumers purchase fewer goods and services, businesses might make cuts to wages, investments, and production, or lay off employees. Increased unemployment means a continuing decline in consumer spending.
Interest Rate Increase
The Federal Reserve adjusts interest rates to maintain the strength of the dollar and control inflation. The rate that affects markets is the federal funds rate, which is the rate banks are charged for borrowing money from the Federal Reserve. Raising it can make money more expensive to obtain and may limit liquidity.
When there is a lack of funds available in the credit market, it can become difficult for borrowers to obtain financing. This might occur when lenders increase the cost of borrowing to a higher rate, or when they have limited funds to lend.
Increased Federal Reserve interest rates can lead to a credit crunch, as can a housing crisis where borrowers default on their loans.
Changes in Regulations
Government regulations can lead to economic shifts. Wage-price controls, minimum wage laws, rent control, and loan-to-value ratios for banks can affect the cost of goods, the rate of unemployment, and balance of supply and demand.
Negative Effects of Recessions
Understanding the effects of a recession is one of the best ways to survive it. Some of the negative effects of a recession are:
Millions of people lose jobs during and following recessions. The unemployment rate tends to peak at 6% to 11% during a recession.
Involuntary unemployment and losses can lead to intense anxiety, fear, stress, and anger. In the worst case scenario this can result in hospital admissions and premature death. Even those who keep their jobs and houses may find that recession times are emotionally challenging.
Loss in Asset Values
Recessions result in losses to the value of stock portfolios, real estate, and other assets.
Are Recessions All Bad?
Enough of the bad news for a minute, let’s talk about some of the potential upsides a recession can have if you’re prepared for it. There can be enormous investment potential and the chance to make broad lifestyle improvements if you keep a long term perspective.
Lower Real Estate Prices
If you’re looking to purchase, build, or remodel a home, and still have the resources after a market crash, a recession can be a great time to do so. If you already own a home, it can be a good time to refinance due to lower mortgage lending rates.
Other goods tend to become less expensive as well, so if you’ve had your eye on a new car or sofa, you might want to buy while the market is down. Stocks may also lose value during a recession, so it can be a good time to buy.
Bye Bye, Bad Customer Service
Failing businesses may not be something to celebrate, but the fact is that inefficiency, frivolous spending, bad customer service, and poor management don’t stick around long during hard times. At the same time, difficult circumstances can bring dedicated teams together, forcing them to use fewer resources and produce better products and services.
Balancing Economic Growth
Unchecked growth can lead to high inflation and overcapacity. A recession rebalances the economy and the value of currency.
Interest Rate Drops
Borrowing becomes easier during a recession because of lower interest rates, so it can be a good time to take out a mortgage or business loan.
Rethinking Core Values and Making Lifestyle Changes
Hard times force us to take a step back and look at our lives from a different perspective. We can strategize about how to do things better, become more self reliant, and tighten up our financial plans for future success. Some choose to spend more time with friends and family, let go of attachments to excess material possessions, or pursue new career paths.
People tend to eat healthier when they cook at home more, and are happier when they spend time with loved ones. A recession can be a great time to start a business, so if you lose your job, create your own.
Rents can be cheaper, wages are low, supplies are discounted, and borrowing is easier. More than half the companies on the 2009 Fortune 500 List were started during recessions or depressions, including General Electric, Disney, IBM, and Microsoft.
Preparing for the Next Recession
Whether it’s this year or three years from now, another recession is bound to happen. While it may be impossible to predict exactly when the next recession will occur, you can start taking steps to prepare your finances now.
Here are some of the key things you can do to help prepare:
Building an Emergency Fund
Do you have enough savings to live off of for three to six months? Create a goal amount for your emergency fund, and start saving towards it each month.
Starting a Side Hustle
Creating multiple income streams can help soften the blow if you lose your job. Thanks to the gig economy and the popularity of side hustles, there are many options for flexible side jobs to diversify your income.
Paying Off Debts
Credit card debt can silently eat away at your income if you don’t pay it off every month, and if you lose your job it can become harder and harder to pay off. Two popular ways to think about paying off your debt are the debt avalanche and the debt snowball.
Using the Debt Avalanche approach, you start by paying off the accounts with the highest interest rate, and work your way down. With the Debt Snowball, you pay off the accounts with the lowest balances first, then move to the higher ones.
Reviewing Your Investment Portfolio
During the last recession, Americans lost nearly $2.7 trillion in retirement savings from 401(k)s and IRAs. Taking a look at your own accounts, you may decide to adjust your investment strategies to be more conservative.
Keep in mind how many years you have until retirement and make your decisions accordingly. You might want to run through worst case scenarios with any real estate or other investments as well. SoFi can help you come up with an investment strategy to fit your risk tolerance and goals.
Be Employee of the Month, Every Month
In case your company is forced to lay off employees, how can you best position yourself to keep your job? Show up to work early, acquire new skills, make your voice heard in meetings, and become indispensable.
Staying in the Hunt
Whether you love your job or dread waking up every Monday, it doesn’t hurt to be prepared to look for a new one. Consider keeping your resume, portfolio, and LinkedIn updated. Catch up with the people in your network, attend conferences, reach out to interesting people in your industry, and make new friends.
If you aren’t already in the habit of paying attention to economic news, you may want to start. Being knowledgeable about loan and interest rates, world trade, stock trends, and other indicators can help you be both financially and mentally prepared for when the recession does hit.
Keeping Calm and Developing a Long Term Perspective
Emotions can be one of the greatest roadblocks to strong investment returns. People have a tendency to buy high on excitement and then sell on fear when the market goes down. But timing the stock market rarely works. Keep in mind that the economy has cycles, and you’ll likely see more ups and downs throughout your lifetime.
You’re Not Alone
Keeping track of your investments during changing economic cycles can be complicated and stressful, as if there wasn’t already enough stress associated with recessions. One of the benefits of using auto-investing is that it takes rebalancing your portfolio off your plate.
You don’t have to tackle recession planning alone. SoFi financial planners can answer your questions, and with SoFi automated investing you can invest your money based on your goals and comfort with risk.
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