During challenging financial times, cash and liquidity is king. Having easy access to cash during a recession can help you avoid going into serious debt.
As a financial planner, I can tell you that no one can predict whether we will enter a recession or if they will experience job loss. However, it is essential to prepare yourself for the possibility.
1. Tighten up your budget
With a potential recession looming, it is a good time to evaluate your budget. Create a list of priorities to determine needs versus wants, keep all your needs on the list, and rank your wants. Plan to keep only your top three to five wants and cut the rest.
2. Save for predictable expenses
In addition, consider using the zero-based budgeting method where every dollar earned has a job. I also recommend creating sinking funds — separate pots of savings — for high-priority, predictable expenses. For example, car maintenance, medical expenses, and planned vacations.
These are annual expenses that you can safely predict will occur. Save a pre-determined amount each month to the various sinking funds. That way you can minimize the need to tap into your emergency fund for any smaller medical or car emergencies that may happen. I recommend you keep your sinking funds in a FDIC insured high-yield savings account.
3. Pay down high-interest debt, and consider consolidating
Having high-interest debt can be a significant burden on your available cash flow. Consider using any extra income to pay down your high-interest debt (i.e. credit card debt).
If you have a good credit score, it may be worthwhile to consolidate your credit card debt into an unsecured (no collateral) personal loan. This may provide you with a significantly lower interest rate, allowing you to pay down the debt quicker. When choosing a personal loan provider, do not forget to consider any origination fee charged for the consolidation.
Another option to consider is a balance transfer credit card that offers a 0% APR during a defined promotional period. This option only makes sense if you have good credit, and you expect to pay most or all the credit card balance during the promotional period.
When comparing balance transfer credit cards, remember that most of these cards will come with a one-time balance transfer fee of 3% to 5% of the amount transferred. Be sure to calculate whether the interest you will save justifies the fee.
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4. Pick up a side gig or part-time job
Recession or not, it is always a great idea to earn some supplemental income. This income can help you achieve various goals such as paying down debt quicker, building an emergency fund, and creating extra cash flow.
Consider using your current skill set to start a side gig such as consulting, creating an online course, or writing a blog. Or if you have some extra time, consider part-time seasonal work.
5. Beef up your emergency fund
One of the most important ways to prepare yourself for a recession is to build a solid emergency fund. Typically, personal finance experts recommend you save three to six months of expenses in an emergency fund. Personally, I advocate for individuals to save six to 12 months of expenses. To determine an appropriate amount to save, you should consider your family needs, job stability, and fixed expenses.
At first glance this amount, may seem daunting and overwhelming. However, if you save a small amount each month, you will slowly build towards your goal. To ensure that your money is working for you but still easily accessible, I recommend that you save your emergency fund in an FDIC insured high-yield savings account.
In addition, if you are responsible with your credit cards and you pay the bill off every month, consider using any cash back credit cards to help build your emergency fund sooner. Or designate the money from your side hustle for emergency savings.
6. Delay big purchases
During economic downturns you want to have as much cash on hand as possible. If it is not absolutely necessary, it may be best to delay any big-ticket purchases. Big purchases, such as a car or house, typically require you to either put down a large lump sum of cash or have a hefty ongoing payment. This would reduce your available cash flow, putting you at major risk if a recession were to occur. Taking on new debt before a recession is very risky and should be approached with caution.
If you are comfortable with your financial situation, have job stability, and have the cash reserves, big ticket purchases may still be achievable for you. But if you are feeling financially vulnerable to the possibility of an economic downturn, it is worth it to keep more cash on hand. By creating a financial cushion for yourself, you can face the future of a potential recession more confidently.
This article was originally published in December 2022.