How Would a Recession Affect Me and My Finances? We're publishing this article in 2023, a year many experts predicted would see the U.S. economy enter a recession. As we wait to see whether the National Bureau of Economic...

We're publishing this article in 2023, a year many experts predicted would see the U.S. economy enter a recession. As we wait to see whether the National Bureau of Economic Research (NBER) will declare a recession, it's worth considering how a recession would affect you and your finances.

What can you expect to happen to your lifestyle during a recession? Are there ways you can profit from it? Can you do anything now to prepare?

Key Takeaways

• As interest rates rise, financing large purchases becomes more expensive.
• Layoffs may increase if the economy continues to slow, making it harder to find stable employment.
• Strategies for surviving a recession include paying down debt, increasing savings, and creating a budget specific to your financial situation.

Impact of Higher Interest Rates

Fear of recession often accompanies rate hikes from the Federal Reserve. The Fed uses rate hikes to slow the economy when inflation is high to keep growth sustainable. Though the Fed always hopes for a soft landing in which the economy doesn't go into recession due to rate hikes, it's a tall order to achieve that.

Between March 2022 and March 2023, the Federal Reserve raised the federal funds target rate by 475 basis points (4.75%). The most immediate impact of rate hikes is that the cost of borrowing increases. Consumers can expect to pay more when shopping for a mortgage or a car. You may also pay more on interest if you carry a credit card balance (remember to pay off that balance every month if you can!).

The other side of the coin is that you'll likely get a boost from rate hikes if you have savings. Because a higher fed funds rate means banks pay more to borrow from each other's reserves, banks use higher savings rates to entice you to deposit your money so they can make loans. Many high-yield online savings accounts paying around 1% at the start of 2022 were 3% or more at the beginning of 2023.

If you need to borrow money when rates are high, make sure it is for something you must have now and that you borrow as little as possible to minimize the interest you pay.

Large Purchases

Even though the cost of borrowing increases when rates are high, the silver lining is you can save money more effectively for your next home- or car-related purchase. If you already have the financial bandwidth to make a big purchase, though, one advantage of doing it while rates are high is that demand for homes is usually low, causing some sellers to lower their prices.

One way you can save is by negotiating. With fewer buyers in the housing market, there is a lower chance of a bidding war driving prices higher. Also, there is a greater chance your offer will be the only one made, allowing you to buy a house at less than the asking price.

If you buy a car, you may save money as well. During the pandemic, new and used car prices skyrocketed. However, that trend for used vehicles is passing as prices slowly drop. Consider shopping for a used car to save money if you need a new vehicle.

Slowing Job Market

A slowing economy often brings layoffs and hiring freezes with it. There is a chance you will lose your job during a recession.

One way some people try to avoid the first round of job cuts is to make themselves indispensable to their team. They take work from their boss, help co-workers with their workload, and find project teams to join. The more valuable you can become, the less likely your company will let you go.

You can also update your resume. You likely haven't done this since your last job. Take the time to update it with your current skills and accomplishments so that you can start looking for a new job immediately if you lose your current one.

Finally, consider finding a side hustle to realize additional income. A second job can help you pay down debt or build your savings. If you lose your job and have a side hustle, you'll still have some income while looking for your next job.

Be Resourceful

A recession causes financial hardship for many people. The lifestyle you are accustomed to may not be possible in a future where money is tight. You can take steps now to handle these changes better when they occur.

Reducing your living expenses will go a long way in making your money last if you lose your job or take a pay cut. Take advantage of the dollar store to lower the cost of purchases. Turn down your thermostat, dress in layers, or use blankets to stay warm.

Finally, evaluate if you need something before buying it. Ask yourself if you need to have something now or if it can wait. The more things you can do to lower your living expenses, the easier getting through a recession will be.

Unknown Variables

While no one knows how long a recession will last or how bad it will get, most experts agree that a potential recession in 2023 would be short-lived and mild. However, experts can only base their predictions on our current information.

There are unknown variables that could change things dramatically. Here is what to keep an eye on.

Supply Chain

Disruptions to the supply chain can drive inflation up due to limited supply. The supply chain was significantly disrupted during the pandemic, causing shortages and price spikes. While most issues have been ironed out, things are not yet back to normal.

What's more, other issues can arise while post-pandemic problems are settling. Take, for example, the threat of a railroad worker's strike we saw at the end of 2022. Had railroad workers gone on strike, it would have been a significant disruption to the supply chain in the U.S.

Russia-Ukraine Conflict

The ongoing conflict between Russia and Ukraine is arguably the most significant unknown variable. It would benefit the global economy if the two countries reached a deal to end the conflict.

The stock market would also likely rally on the news, and oil prices would drop.

But if the conflict escalates and other nations join it, it could have severe consequences. There could be supply chain issues, higher gas prices, and more.

What Do I Do Now?

Now that you know how a recession could impact you and the factors that could make it mild or severe, what are some smart things you should be doing with your money now and during the recession? Here are a few ideas.

Invest Wisely

A recession is a great time to buy certain stocks at a discount. Even though the stock market typically declines during a recession, it doesn't mean you should not be actively investing. There are two strategies you can use to invest during a declining market.

First, you can invest in individual stocks. Do your research to determine when stocks are selling at a discount.

If you go this route, only invest a percentage of the money you plan to at any given time. No one knows where the bottom is, so you can mitigate risk by putting 25% of your available investing money into the market at a time.

The other option is to use a dollar-cost-averaging strategy. With this tactic, you take a set amount of money and invest it regularly in smaller amounts. This reduces the impact of temporary market movements on your investment.

Whichever strategy you use, keep your emotions in check. Over an extended period, the economy generally increases, so pulling your money out of the market because of a temporary drop in prices may not benefit you in the long run.

Increase Savings

Another money adjustment to make is increasing your savings. Higher interest rates can make saving more effective. With the Fed aggressively raising rates, many high-yield savings accounts now pay over 3% interest.

You can also consider short-term Treasuries and I bonds, which typically have higher returns than savings accounts.

Regarding savings, look for products that will give you a competitive interest rate.

Reduce Debt

If you have high-interest debt, you should work hard to pay down your balances. There are a couple of reasons for this.

First, your interest rate on variable debt (such as adjustable-rate mortgages and credit cards) will continue to climb as the Fed raises rates. This will make your debt even more expensive.

Second, with recession comes the risk of job loss. While unemployment is stressful, having a mountain of bills to pay simultaneously is even more stressful.

By paying off some of your debt, you free up money you can use to pay for daily living expenses. Even if you think your job is safe, it is wise to pay down debt since having debt holds you back financially.

The Bottom Line

A recession will impact everyone differently. Some people will lose their jobs, while others will find themselves priced out of buying a home. The critical thing to do is to take some time, look at your financial situation, and create a plan. Do you have significant amounts of debt you should pay off? Are you at risk of losing your job? Do you have savings you can live off of? How will higher interest rates impact your large purchases moving forward?

The more time you take to understand how a recession will affect you, the better you can plan for and minimize its impact on your financial health.

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