Your Guide: How To Prepare For A Recession In 8 Steps

Whether or not a recession is coming is a constant discussion in the news. With such a complicated subject, even the most knowledgeable experts can disagree. While no one can perfectly predict when a recession will occur, knowing the signs of an economic downturn can be helpful. Once you recognize these indicators, knowing how to prepare for a recession will give you the tools to overcome any dark days ahead.

Americans can prepare for a recession by taking a few concrete steps to safeguard their finances.

1.  Establish A Budget

2.  Be Strategic About Big Purchases

3.  Reduce Your Credit Card Debt

4.  Grow Your Emergency Fund

5.  Get A Side Job

6.  Update Your Resume

7.  Continue Saving For Retirement

8.  Diversify Your Investment Portfolio

Before getting into preparing for a recession, it’s important to understand what one is and what signs to looks for.

What Is A Recession?

The National Bureau of Economic Research (NBER) defines a recession as: “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” NBER analyzes business cycles and determines the U.S. economy's peaks, troughs, and turning points. 

Their definition is somewhat vague for a reason: determining whether we’re in a recession involves many variables, so they don’t use an exact definition.

Key Considerations For Spotting A Recession

Since there is no one way to spot if a recession is on the way, you must look at a wide array of economic indicators to get a sense of the economy. Below are some of the most critical indicators NBER uses and how they currently appear in the U.S. economy.

National GDP

U.S. Gross Domestic Product (GDP), one of the most common economic indicators, measures the value of goods and services produced in the United States. Economists often use Real GDP because it accounts for inflation. If a country’s Real GDP is declining or even growing at a slower pace than normal, a recession could be on the way.

U.S. Real GDP increased by 1.1% in Q1 2023, a slower rate than the 2.6% increase in Q4 2022 and the 3.2% increase in Q3 2022. While the economy is still growing, three straight quarters of slowing economic growth may be a sign that a recession is on the way.

Personal Income

Personal income statistics are some of the most highly weighted indicators that NBER uses to measure recessions. NBER uses the real personal income less transfers (PILT) measurement to analyze personal income. PILT accounts for monetary income, such as salaries, and nonmonetary income, such as employer-sponsored health care. However, it subtracts income from government social insurance programs. It also accounts for inflation.

Like U.S. Real GDP, personal income has increased over the last three quarters, but at a slower pace each quarter. After a 1.1% increase in Q3 2022, personal income increased by 0.7% in Q4 2022 and 0.3% in Q1 2023.

Employment Statistics

The most common employment statistic is the unemployment rate, the percentage of the workforce that does not have a job. The unemployment rate remains strong at 3.4% after staying between 3.7% and 3.4% since March 2022.

Industrial Production

The output of industrial businesses like mining, manufacturing, electricity and gas is measured by the Industrial Production Index. If this measurement declines, it could indicate that industrial companies are receiving less business, leading to layoffs, lower wages and a recession. After a huge rebound from the shock of the pandemic, industrial production growth slowed before declining by 0.6% in Q4 2022 and 0.1% in Q1 2023.

Wholesale-Retail Sales

Wholesale-retail sales are leading indicators of economic health that allow economists to identify consumer trends. One of the key measurements is the ratio of inventories to sales within wholesalers. If a wholesaler’s inventory increases faster than its sales, it may lower production, leading to layoffs and decreased GDP.

The U.S. wholesale inventories to sales ratio increased steadily over 2022 as manufacturing increased following the pandemic, but the ratio remained unchanged from Q4 2022 to Q1 2023.

8 Ideas To Prepare For A Recession

Based on the indicators above, the effect of persistent inflation and several bank failures in recent months, the Federal Reserve Board predicts a mild recession to begin late this year. Follow the 8 steps below to prepare for this economic downturn.

1. Establish A Budget

The cornerstone for your financial decisions should be your budget, especially if you believe a recession is coming. To get started, document your income and living expenses to determine your monthly cash flow. Once you have this data organized, you can identify your essential expenses, like your rent, and your nonessential expenses, like all the subscriptions you forgot to cancel.

2. Be Strategic About Big Purchases

Big purchases like real estate or cars can derail any budget affected by a recession. You may be able to afford a house at the top of your current budget today, but have you considered whether you can afford it if a recession causes you to lose your job? If you believe a recession is on the way, the best strategy may be to wait to make big purchases. If your financial situation remains strong through the downturn, but prices fall, you could get a better deal.

3. Reduce Your Credit Card Debt

Relieving debt is a priority for everyone, but especially if you’re trying to recession-proof your finances. Your first step should be clearing credit card debt with high interest rates, which saves money on finance charges while clearing up available credit. It also protects you in an increasing interest rate environment.

4. Grow Your Emergency Fund

With less debt, you can save more money by setting aside an emergency fund. Saving up 3 – 6 months’ worth of expenses as a safety net ensures you won’t be forced to use high-interest credit cards during tough times or take out a personal loan, which may be difficult during a recession.

5. Get A Side Job

If your primary income can’t cover your essential expenses, you may want to consider taking on a side hustle. If you do your best to live off the money you earn with side gigs, you can put away most of your primary income after bills. Plus, if you find yourself unemployed, you have an income to fall back on and a little extra savings to help you get by.

6. Update Your Resume

Even if you feel confident that you’re safe from losing your job in a recession, updating your resume is always wise. This way, if you do unfortunately lose your job, you can be ready to start the hunt for a new one immediately.

7. Continue Saving For Retirement

If you have a sound budget with minimal debt payments, you must continue saving for retirement in a recession. The younger you are, the easier it is to ride out a recession. You won’t need to draw from your retirement accounts for a while, so you have time to allow investments to recover. However, if you stop investing in retirement savings and investment accounts out of fear of a market downturn, you could miss out on the recovery and significantly hurt your retirement goals.

8. Diversify Your Investment Portfolio

Be sure that your portfolio is balanced and that you’re only assuming as much risk as you can afford. If you don’t have years to recover from a significant portfolio hit, rebalance your portfolio to include more “safe” products – like bonds and mutual funds – and fewer riskier ones, like individual stocks.

The Bottom Line: You Can Take Steps To Prepare For A Recession

An economic downturn doesn’t have to feel like the end of the world if you recognize the signs and know how to prepare for recession. If you follow the indicators above and follow the steps to prepare your budget, eliminate debt, secure your income streams and continue investing responsibly, you can ride out any storm. It’s also helpful to speak to a financial advisor.

Knowing exactly what’s happening with your money can help you when a recession looms. Download the Rocket Money℠ app today to get full visibility into what you owe, what you get paid and what you’ve saved or invested.