There has been much talk of a US recession or even a global recession occurring in 2023. Economists and analysts are predicting that a recession is highly likely to occur during the year. Some predict a mild recession while others predict a more catastrophic situation. But what is a recession and how should you prepare for such an event?
A recession is defined as a significant decrease in economic activity, which may last for a prolonged period. Usually, an economy is in a recession when this decrease in economic activity occurs over a period of at least two consecutive quarters. During periods of recession, the decrease in economic activity may also lead to a decrease in employment levels and a decrease in consumer spending. Simply put, less production means less workers are needed, and lower employment levels leads to less disposable income for consumers to purchase goods and services. Lower consumption of goods and services can lead to further decrease in economic activity and therefore creates a cycle. Governments are then forced to use fiscal and monetary policies to prevent a recession or to bring it to an end.
Without proper planning a recession can irrevocably damage your financial stability. How would you survive if you lost your job or if your business profitability reduced significantly? Funding your daily needs would become more difficult and proper preparation and planning is important to ensure that you are able to withstand such situations.
One important step to take is to create a budget. This will help you to determine your financial position as you itemize your expenses and compare them to your income. You can use this to determine if there is a surplus of cash remaining after your expenses have been paid and if there is, this surplus can be saved or invested for future use. If there is no surplus cash or if there is a deficit, the budget will allow you to determine which expenses are “needs” and which ones are “wants”. Prioritize the needs and reduce the unnecessary wants, as doing so will help to create a surplus which can be saved and invested for future use.
Another important step in preparing for a recession is to have some savings set aside in an emergency fund. Ideally an emergency fund should have enough money to cover living expenses for a few months. This can be done using a savings account which is held separately from the bank account used for your daily transactions. This will ensure that you do not spend from the emergency fund inadvertently. As the saying goes, “out of sight, out of mind”. An investment account which is highly liquid can also be used to create this emergency fund. Having an investment instrument such as a repurchase agreement (repo) will allow access to the funds as needed and will earn more interest than a savings account will earn. If the worst should occur, the emergency fund will be available to cover your expenses for a few months, and hopefully normalcy will be returned within that period. Having this fund will also help you to avoid having to liquidate your investments or other assets during a time when the market prices may be low.
In preparation, you should also look to pay down high interest rate debt. Paying these off early will better prepare you for economic difficulty and this will reduce your monthly expenses, allowing for more saving or disposable income which can be deployed to other important expenses during a recession.
Before a recession, it is also important to create streams of passive income. Look for investments which provide income, such as a bond. Speak with your financial advisor to select bond investments which meet your risk appetite and are issued by borrowers that can survive a recession and meet their payment obligations to you. By doing this, if income from your business or your job is reduced or non-existent, the income from your investments will help to cover your expenses. The bonds will provide predictable income that you can include in your budget. When purchasing the bonds, you will be advised of the interest payment amounts and dates which will help with your planning.
A recession may or may not occur and if it does it may be mild or it may be severe. Being prepared will help you through the recession if it happens and if it does not, you will be in a better financial position to take advantage of opportunities as they arise.
Dwayne Neil, MBA, is the AVP, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: if you wish to have Sterling address your investment questions in upcoming articles, e-mail us at info@sterlingasset.net.jm.