As of 2023, the stimulus money faucet has been turned off, and the Fed is aggressively raising interest rates to fight off high inflation. This has led many economists to predict a recession sometime in 2023 or early 2024. The real question is, if a recession does indeed come, what exactly does it mean for you?
What Exactly Is a Recession Anyway?
Technically, a recession is defined by economists as two consecutive months of economic retraction. But on a real-world basis, a recession is a tangible economic slowdown, usually accompanied by job losses and shrinking corporate profitability.
In the investment world, a recession typically occurs during a period of rising interest rates and decreasing stock prices. In fact, those are often predictors of a coming recession. It is not until the end of a recession that interest rates usually hit their low, and stock prices resume their upward climb.
What Does a Recession Mean to the Average Person?
Recessions are generally periods of economic uncertainty. To the average person, this usually means that they have to build up their cash reserves and trim discretionary expenses in case of job loss or an extended economic decline. Those in the stock market will either have to alter their investment strategy and become more conservative or take the tough emotional hit as they watch their portfolio value decline.
Household budgets tend to get tighter during recessions also, as high interest rates make everything from home mortgages and auto loans to credit card debt more expensive. In a nutshell, day-to-day living tends to be more costly during a recession than before or after one.
How Does a Recession Affect Me Personally?
A recession can mean very different things to different people. It all depends on your own personal financial situation. For example, if you’re not a stock market investor, it might not affect you at all if there’s a bear market and stock values drop by 20%. If you have a solid, steady job, rising unemployment might not hurt you either.
But the opposite may be true as well. If you end up losing your job during a recession, it could send you into a financial tailspin, unless you’ve got an adequate emergency fund. If most of your investments are tied up in the stock market, a 20% or 30% selloff could put you a year or more behind where your financial plan projects you might be.
How To Be Prepared
It’s essential to have a well-stocked emergency fund with at least three to six months’ worth of expenses. When a recession hits — and they occur with regularity — there’s no way of knowing for sure if you will keep your job or if rampant inflation and interest rates will drive up the cost of living to the point that you have to go into debt just to keep up.
Although the timing of a recession is always a mystery, it’s a fact of the business cycle that they will continually come and go. Preparing ahead of time is the best way to be able to handle any economic setbacks that come your way.
What Happens If We Go Into a Recession?
Regarding the economy as a whole, a recession essentially means a slowdown in everything. Consumers start trimming their expenses, starting with discretionary items like travel and fancy cars, and then go a step further and only buy basic essentials — “needs” instead of “wants.” Companies slow down their production lines and institute hiring freezes — or even worse, initiate layoffs.
Overall, cash flows, both personal and business, tend to shrink, and debt levels rise.
Who Benefits From a Recession?
As consumers cut back on their spending during a recession, lower-end retailers tend to benefit, as their lower costs attract more budget-minded customers. Businesses that rely on customers with financial difficulties, like pawn brokers and bankruptcy attorneys, can also see revenue spike during a recession. Companies selling consumer staples like toothpaste and toilet paper also tend to hold up well during economic contractions.
While a recession is generally viewed as a bad thing, there are businesses, industries and individuals that all benefit from economic contractions.
The Bottom Line
Generally speaking, a recession isn’t a great thing for individuals or the country as a whole. But with some advance preparation, you can often diminish the negative effects of a recession.
Building an emergency fund, paying down debt, making yourself indispensable at your job and actually adding to your stock market investments during a correction can help you weather a recession and actually boost your long-term wealth.