How to Recession-Proof Your Savings
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Ever since the pandemic began, financial experts and economic pundits have been discussing an economic downturn on the horizon. To date, that hasn’t quite materialized. However, with thousands of layoffs from major tech companies and inflation continuing to remain high, it wouldn’t be surprising if a recession did begin. Some personal finance writers say we may already be in a recession.
If (or when) a recession hits, the impact can be pretty major. Recessions have far-reaching negative effects, from volatility in the stock market affecting your retirement account to rate hikes for interest rates and job loss. As such, it’s prudent to try and prepare as best you can to weather the storm of a recession — rather than be victim to the whims of an uncertain economy.
If you’re taking your financial planning seriously, finding ways to recession-proof your savings is wise. While it’s not healthy to be an alarmist about the economy, there are certainly concrete steps you can take to help protect your savings and recession-proof your savings accounts. Keep reading for a survey of different tactics, tips, and tricks to get your finances on track as you prepare for an impending (or not) recession.
In this article
What is a recession?
It can be easy to get lost in discussions of Gross Domestic Product (GDP) when discussing recessions. While economically, these factors are important to understand, it’s more useful for the layperson to understand more generally what happens in a recession and how it affects them and their financial goals
Put simply, a recession occurs when the market value of all goods in a country decreases for two quarters in a row. This decrease can stem from a wide variety of factors, including, but not limited to:
- Rising interest rates
- Changes in economic policy
- A housing downturn
- Natural disasters or global political events
- Consumer confidence falling
- Stock market crashes
None of these factors is great to experience on its own, and during an economic recession, the impact may be felt even more acutely. For example, a recession may cause widespread layoffs and also reduce consumer spending, which, in turn, can hurt businesses.
Strategies to recession-proof your savings
Nobody wants to be adversely affected by a recession more than they can afford to. If you’re interested in helping recession-proof your savings and day-to-day finances, here are some strategies to consider implementing.
Build up your emergency fund
This may seem obvious, but if you have an emergency fund you will be well-positioned for an economic downturn by not relying on your paycheck so religiously. If you have the funds to set aside to build up your emergency fund immediately, it’s a good idea to do so now if you haven’t classified them as your emergency fund yet. Keep in mind that most people may need to build up their emergency fund over a few months.
How much should you save for your emergency fund?
There are a few different philosophies regarding how much to save when setting a savings goal. For beginners who don’t yet have an emergency fund, a general rule of thumb is to save at least $1,000 in a savings account for emergencies. This method is championed by Dave Ramsey and can be especially useful if you’re trying to get out of debt simultaneously.
On the other hand, many personal finance advisors recommend bulking up your personal emergency fund beyond just $1,000. Setting a savings goal of a month’s worth of living expenses is a great benchmark. You can build up to two or three expenses from their months’ of living. Some people have saved an entire year’s income as their emergency fund, giving them peace of mind in the face of an economic downturn!
How should you save your emergency fund?
The general wisdom is to keep your emergency fund semi-liquid, saving it in a savings account. However, you may want to look into using a high-yield savings account to have your emergency fund earn a little bit of interest as it sits there. While you won’t likely get rich off of your emergency fund, it never hurts to grow it naturally while you don’t touch it.
Eliminate debt
Getting out of debt is a great strategy in pretty much any scenario, and if you’re trying to recession-proof your savings, this step is even more important. This is because high-interest debt can really weigh you down in an economic recession.
During a downturn, many lenders will raise interest rates to protect their own profit margins. That negatively impacts consumers with high-interest loans or credit card debt. If you carry a balance, consumer debt can quickly become a ball-and-chain in a recession, demanding more and more of your hard-earned money in interest payments.
There are a variety of strategies you may want to use to eliminate debt. Two of the most common ways to reduce debt include the snowball method and the avalanche method. These debt payoff methods have pros and cons, but both are tried-and-true ways to eliminate your debt, so look at them if you’re trying to get out of debt.
Diversify your investment portfolio
In the event of a recession, having too many of your eggs in the same basket can be really detrimental to your financial goals. This is especially true if you are close to retirement age or are already retired since your asset allocation plays an even larger role in your monthly income.
Whether you’re saving in a 401k retirement plan or an IRA, diversification is an investing strategy that you can use to spread out your risk and reduce the overall impact a hit to the stock market would have on your finances.
Increase your earning potential
Sometimes, the best way to recession-proof your savings is to increase your earning potential in the short term. Doing this allows you to live on the money you are used to making while increasing your annual income. That gives you more flexibility in saving aggressively for your retirement, emergency fund, or even paying off your debt faster.
Whether you take on a part-time job or choose a more flexible side hustle is up to you; increasing your monthly take-home pay is important. This can act as a buffer when the economy is doing well and, at the very least, keeps you from filing for unemployment if you are laid off.
Stay informed — but don’t panic
It can be easy to get sucked into negative news cycles. At the same time, the best defense is a strong offense — and in the world of finance, that often involves reading up on changes to the market.
Staying informed doesn’t mean being reactionary. However, it does mean staying proactive in how you handle your finances. For example, if you’re concerned about some of the headlines you’ve seen, you may talk to your financial advisor to get their perspective on certain events.
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Costs and fees
Opportunity costs
Opportunity costs are the only real costs you’ll face when taking advantage of any of the above strategies. If you haven’t yet saved for an emergency fund, you may have to sacrifice eating out for a little bit to build up your savings fund quickly. Or, if you’re paying off debt, you may wind up compromising on how much you can invest in your retirement account. Ultimately, weighing these trade-offs—and the security they offer—is an important aspect of recession-proofing your savings on the best timeline for you.
Financial advisor fees
Some investors choose to work with a financial advisor when they’re trying to recession-proof their savings. While this is unnecessary, it could give you more confidence on how and when you’re diversifying your portfolio.
Keep in mind that financial advisors usually charge a percentage fee based on the amount of money they manage for you. Typically, this fee ranges from 0.25% to 1% per year, meaning that if they manage a portfolio worth $500,000, you would be paying anywhere from $1,250 to $5,000 a year. That may not sound like a large amount of money, but you are leaving money on the table that you would otherwise earn in investment gains.
Pros and cons
Pros
- Protects against losses. A recession can cause major losses if you’re caught off guard. By diversifying your investment portfolio and building up an emergency fund, you can help safeguard your finances from taking major hits. This ultimately protects you from losing as much money, a major benefit of taking steps to recession-proof your savings.
- Peace of mind. Recessions are uncertain and scary. Especially when those feelings involve your finances and your financial future, it’s easy to have your financial concerns take a toll on your mental and physical health. By recession-proofing your savings, you know that you’ve taken actionable steps to prevent major losses in a downturn.
- More secure portfolio. Diversifying your assets helps protect your investments from more than just a downturn. For example, diversifying your investments will shield your portfolio from big losses in the event of a stock market decline or a bond market decline.
Cons
- Can lead to limited returns. Diversifying your portfolio reduces risk, which could result in lower returns than if you were investing full-steam ahead with your normal risk tolerance. If you want to maximize your investment returns, you likely need to make bolder choices with your portfolio — which can be at odds with recession-proofing your savings.
- Requires making sacrifices short-term. As was mentioned earlier, there are opportunity costs in the short term that are needed by building up an emergency fund or reducing your debt. These short-term sacrifices should be weighed as you calculate what makes the most sense for you and your finances.
- Takes time and energy. Especially if part of your recession-proofing strategy involves paying down a large debt, a lot of time and energy is involved in recession-proofing your savings. If you struggle with tasks requiring willpower, it’s important that you’re realistic with yourself about your financial abilities.
The bottom line
Nobody wants to have their lives turned upside down by a recession. Especially for millennials like myself, who have lived through various economically tumultuous and globally fraught events, it can be easy to worry about money and the power of an external event to hurt your financial future.
If you’re anxious about what a recession might mean for your financial goals, the above strategies can give you peace of mind and protect you against major losses. Saving up an emergency fund, staying on top of the news, and reducing your high-interest debt all have a role to play in protecting your finances. Diversifying your investment portfolio can also help spread some of your investing risks.
Of course, even the best-laid plans sometimes need help combat major economic events. If your emergency fund is only enough to keep you afloat for a month, losing your job and going on unemployment for three months can still be a big financial hit. Some people may balk at the opportunity cost of building up an emergency fund or paying down debt — particularly in a volatile market where big swings can sometimes mean big wins in the stock market.
Even so, taking steps like the ones above can help reduce the overall losses you face and ultimately might be why you stay afloat financially. When recession-proofing your savings and finances, it’s best to take a proactive, but not reactionary, approach. This will allow you to keep a clear head and stay the course as you build a strong financial defense.
Better banking is here.
- No account fees
- Earn up to 4.20% APY
- Up to 2-day-early-paycheck
- No-fee Overdraft Coverage.
- Do it all in one app.
- Up to $2M of additional FDIC insurance through a network of participating banks.
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Writer
Brent Ervin-Eickhoff is a Chicago-based writer, stage director, and filmmaker with a background in digital marketing and content creation. In addition to Joy Wallet, Brent has written for Complex, Volkswagen, HowlRound, Picture this Post, and Third Coast Review, among others. He currently serves as the Associate Director of Marketing for Content Creation at Court Theatre at the University of Chicago. Brent graduated from Ball State University with Academic Honors in Writing.
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