Recession survival checklist

A well-functioning economy will move through the four phases of the business cycle: Slowdown, contraction, recovery and expansion. It's often difficult to know which part of the cycle we're in, but as markets react to economic data and corporate earnings, many people equate a stock market decline to an approaching recession. Don't get caught up in the hype – recessions are rare and tend to last only 8 months on average. They do, however, impact everyone differently, so it pays to be prepared.

What is a Recession?

A recession is often characterized as two consecutive quarters of negative growth in a countries gross domestic product (GDP). GDP data is often released one to two months after the quarter ends, meaning that the economy can technically be in a recession, or out of one, before we realize it. The recession of 2020 triggered by the Covid-19 pandemic was the shortest on record - only lasting one month - and is a great example of an economy going into and out of a recession before we have the data to confirm it.

Whether or not the economy moves into a recession or simply experiences an economic slowdown, there are some ways that you and your loved ones can plan for whatever comes next.

How to prepare for a Recession

1. Evaluate your income stability

Start by asking yourself how a recession could affect your income. Are you on a fixed or variable income? Do you run your own business? Are you in an industry that is sensitive to economic downturns? If you conclude that a recession is likely to impact your livelihood, it might be time to start thinking about how you can earn extra income if needed. Alternatives can include freelancing, taking up a side hustle, joining the gig economy, tutoring or even renting a spare room in your basement.

Now might also be a good time to strengthen your professional network and update your resume. Don’t wait until your hours are cut or you lose your job to prepare for the job search.

2. Review your spending

After considering how your income might change, you may conclude that you will need to reduce your spending. If so, start to review your budget to identify areas where you could trim spending if your income were to decline. For example, canceling subscription services you don’t use often, switching to generic brands or reducing spending on entertainment and eating out are areas where you can save money without sacrificing too much of your lifestyle. It might also be a good idea to postpone large purchases (like buying a new car). Instead, you can use that money to build or strengthen your emergency fund. If you need to make a large purchase, try to avoid taking on new debt to pay for it.

3. Pay down your debt

As part of reviewing your spending, be sure to review all your debts, including the amount owed, term, interest rate and required minimum payments, then formulate a plan to pay them down. Prioritize making all the minimum payments first and then focus on your high interest rate debt.

If you have multiple debts with high interest rates and a good credit score, you can explore whether consolidating debt makes sense. Consolidation can lower your monthly payments and interest rates, but you may incur fees and it could negatively impact your credit score.

4. Plan your emergency fund

Even if you manage to earn extra income and cut back on spending, there might still be a gap between your take-home pay and the amount needed to cover your essential needs during a recession. Having an emergency fund in place can help you cover any gaps without having to sell investments, tap into your retirement account or take on debt.

We recommend having 3 to 6 months of total expenses in an emergency fund. So, if you don't have an emergency fund, now is the time to start building one. If you already have one, evaluate whether you are still comfortable with the amount saved based on your income stability and flexibility to adjust spending

5. Review your protection plan

If you were to lose your job or your hours were reduced, you might also lose any insurance tied to your employer, such as health, disability, or life insurance. It’s important to maintain any coverage lost as unexpected events can derail your financial strategy.

Therefore, you might want to start looking into alternatives and costs of maintaining these coverages on your own when planning your recession budget. By knowing your options, you can prevent gaps in coverage and prepare for the higher costs of obtaining this coverage individually.

For any insurance policies you’ve purchased individually, such as home or auto insurance, now might be a good time to see if you can lower your premiums without sacrificing coverage. This could help create more room in your budget.

6. Don’t abandon equity markets

When the fear of a recession is high, it can stir an emotional response and a call to action when it comes to investing. The instinct is to sell stocks or bonds thinking that they will underperform during a recession and then buy them back when the future is uncertain. However, this could lead to underperformance in investor portfolios. Looking closely at stock market performance, we see that stocks typically act as a leading indicator of a recession. That is, by the time a recession materializes, stocks have already priced in much of the slowing growth and the pain has already been felt.

Equity market performance can be quite good at the tail end of a recession, as this is when stocks tend to bottom and even start to rebound. However, investors may not have the opportunity to buy into the more favourable market prices once the recession is over. We also know that some of the best performance days in stock market history come during bear markets and recessions. Missing out on the best days can mean lower long-term returns.

Finally, trying to time the market amid souring consumer confidence can mean getting out at the wrong time or anticipating a recession that never materializes. Falling sentiment and confidence doesn't always lead to a recession, and in fact, recessions sometimes can happen when sentiment is high.

7. Revisit your time horizon and performance expectations

Experiencing short-term market declines can be difficult. Understanding the time horizon for your financial goals and revisiting appropriate long-term performance expectations for your portfolio can make it easier to ride the ups and downs of an economic cycle.

Taking a closer look at consumer sentiment and stock market performance, we see that stocks tend to do well when sentiment is souring and bottoming. Not all periods of falling investor and consumer sentiment lead to recessions, but valuations typically fall as sentiment falls, which can translate into better long-term performance for buyers of stocks. Historically, as stocks moved into bear territory amidst strong consumer spending, the lower stock valuations have set up strong support for equity market returns, which we believe improves the long-term return potential.

In a recession environment, bonds tend to hold up better than equities and offer diversification benefits as well. In addition, yields will likely fall, and prices will rise, translating into better returns for investors.

8. Take stock of how much risk you're willing to take

The amount of risk appropriate for your portfolio is unique to you and your life circumstances. Income, goals, debt, investment horizon, and age can all impact the amount of risk you should take when investing. Too much risk in your portfolio, and you risk losses in the short-term that you might not have expected or were prepared for. Not enough risk in your portfolio, and long-term goals might not be achieved.

Now may be a good time to revisit your comfort with risk as circumstances can change, and your capacity for risk might have increased or decreased since the last time you looked at it. Your risk tolerance plays a crucial role during periods of market volatility as it can affect your investment goals. Investing is all about balance, including balancing the return you need to reach your goals in relation to your comfort level with risk. Determining the most appropriate balance for you will help you build and maintain an investment portfolio for your situation. Check-in with your financial advisor if anything has changed in your life circumstances.

9. Ensure proper diversification across a variety of investments

Diversifying your investments across a variety of stock and bond asset classes, which is often called asset allocation, can help you manage your portfolio’s risk. Determining the right mix of asset classes can help ensure your portfolio is aligned with your comfort with risk and financial goals.

Bonds have historically had lower levels of volatility and risk accompanied by lower total returns, while stocks have higher levels of risk and returns. Additionally, during periods of economic uncertainty, higher-quality bonds, such as Government of Canada bonds, are more likely to move in the opposite direction of stocks, which can enhance diversification when financial conditions are worsening. International investments can provide additional diversification benefits.

Therefore, we believe it’s important to look at your exposure to each asset class to ensure your portfolio is diversified across various segments of the market, helping to prepare you for changing market conditions.

10. Check on your portfolio mix and consider rebalancing

A focus on quality investments can help cushion the impact that an economic downturn may have on a well-diversified portfolio. Your portfolio mix of stocks, bonds, sectors, and styles can shift as different asset classes have non-uniform performance over time. Bringing your portfolio back to your optimal mix helps to mitigate any performance or drawdown surprises during periods of falling stock or bond prices. It has the added benefit of selling high and buying low. For example, if stocks fall significantly, rebalancing will allow for the sale of bonds (relatively expensive) and the purchase of stocks (relatively cheap). Rebalancing also helps with diversification as a single investment with strong outperformance can start representing more of your portfolio than your ideal mix of investment would suggest is appropriate.

If you have yet to work with a dedicated financial advisor, or if you're looking for a new financial advisor in your community, we invite you to meet with one of ours. Edward Jones financial advisors are dedicated to creating a personalized investing strategy based on your situation and your financial goals.