Sep 9, 2022

What is a Recession and Effective Tips to Prepare for One

A recession can be terrifying, even with sufficient planning. The fact that recessions are temporary is their one saving grace. Even the Great Depression came to an end, and the biggest economic expansion in American history probably followed. For a better understanding of "What Is a Recession?" keep reading.

What is a Recession?

A recession is a prolonged drop in economic activity. When a nation's economy faces negative gross domestic product (GDP), growing unemployment, declining retail sales, decreasing indicators of income and manufacturing over an extended period of time, experts declare a recession.

The Official Definition for a Recession 

According to the National Bureau of Economic Research (NBER), a recession is characterized as a significant decline that lasts for more than a few months and affects the entire economy, not just a particular industry. Thus, practically every industry will be impacted. The time period between the peak and the lowest point in economic activity is frequently used to characterize recessions. They often last only a few sentences. An average recession has lasted ten months since the end of World War II. However, the NBER normally does not classify a decline in the economy as a recession until six to 18 months after it has begun.  That means consumers may feel the effects of it before it's officially in place.

Why Do Recessions Occur?

There are many things that can set off a recession, like a sudden shock to the economy or the effects of inflation that gets out of hand. Some of the most common reasons:

  • A sudden change in the economy. A more contemporary illustration is the coronavirus outbreak, which caused global economic collapse.
  • Too much debt: Too much debt could make it too expensive for individuals or organizations to repay it. The economy collapses as more people quit making payments and file for bankruptcy. For instance, the Great Recession was brought on by the mid-2000s housing bubble because of excessive debt.
  • Asset bubbles: When people make investments based solely on emotion, the economy suffers. Irrational optimism is what leads to bubbles in the stock market or the housing market. Panic selling can crash the market and trigger a recession when bubbles burst.
  • Too much inflation: Inflation is the term used when prices keep going up. Although inflation itself is not bad, too much of it is. By raising interest rates, central banks slow the economy in an effort to curb inflation. In the 1970s, inflation in the US was out of control. In an effort to break the cycle, the Fed raised interest rates right away, which led to a recession.
  • Too much deflation: Deflation is worse than out-of-control inflation at starting a recession. Price drops constitute deflation. Falling wages result in lower prices. People and businesses quit spending as a result of deflationary feedback loops, which harms the economy.
  • Technological advancements: While new discoveries boost production and benefit the economy in the long run, they might be difficult to adapt to in the short term. Technology underwent a lot of changes in the 19th century that simplified work. The Industrial Revolution eliminated entire occupations, causing recessions and difficult times.

The Business Cycle and Recessions

The business cycle demonstrates how an economy has times of expansion and periods of decline. When an economic expansion starts, the economy expands in a way that is long-term, stable, and healthy. Over time, lenders make it simpler and less expensive for individuals and corporations to borrow money, which facilitates their ability to take on more debt.

The value of assets increases more quickly and debt grows as the economy continues to expand. At one point in the cycle, one of these things prevents the economy from expanding. The shock causes stock market collapses, asset bubble bursting, and price spikes that make it impossible to service high debt loads. As a result, the economy weakens and enters a recession.

Is a Recession Coming?

It is difficult to predict when the next recession will occur because economic forecasting is challenging. For instance, COVID-19 appeared out of nowhere at the start of 2020. The American economy nearly collapsed within a few months, costing millions of people their jobs. However, there are warning signals that trouble is approaching. If you pay attention to the following, you'll have more time to find out how to get ready for a recession:

1. An inverted yield curve: This is a graph that shows the market value or yield of U.S. government bonds, from short-term to long-term. In a healthy economy, bond rates should be higher. Long-term yields below short-term yields indicate recession fears. "Yield curve inversion" has historically signaled recessions.

2. Decline in consumer confidence: Consumption drives the U.S. economy. Consumer confidence falling could signal a worsening economy. When this drops, consumers don't want to spend money. If they fear spending, the economy slows.

3. Drop in the Leading Economic Index (LEI): The Conference Board's LEI predicts future economic changes monthly. It looks at things like unemployment insurance, factory orders, and the stock market. If LEI falls, the economy could suffer.

4. Sudden drops in the stock market: A big, rapid decrease in the stock market could signal a recession, since investors sell off assets when the economy slows down.

5. Rising unemployment: As the economy worsens, unemployment rises.

How Long Do Recessions Last?

The NBER keeps track of how long U.S. recessions typically last. NBER data show that the average length of a recession from 1945 to 2009 was 11 months. The average length of a recession from 1854 to 1919 was 21.6 months, therefore this is an improvement. The United States has had four recessions over the previous 30 years:

Source: Unemployment data is from the Federal Reserve Bank of St. Louis


- The Covid-19 Recession. The most recent recession started in February 2020 and ended in April 2020. It was the shortest recession in U.S. history.

- The Great Recession (December 2007 to June 2009). As mentioned, part of what led to the Great Recession was a bubble in the real estate market. Even though the Great Recession wasn't as bad as the Great Depression, it was around for a long time and had a lot of bad effects. The Great Recession lasted for 18 months, which is almost twice as long as other recessions in the U.S.

- The Dot Com Recession (March 2001 to November 2001). At the turn of the century, the U.S. had a lot of big economic problems, including the fallout from the tech bubble crash and accounting scandals at companies like Enron. The 9/11 terrorist attacks were the last straw. All of these problems led to a short recession, but the economy quickly recovered.

- The Gulf War Recession (July 1990 to March 1991). At the beginning of the 1990s, the U.S. went through a short, eight-month recession. This was partly caused by the First Gulf War, when oil prices went up.

What a Recession May Mean for You:

Even if an economic slump hasn't been formally dubbed a recession, it can nevertheless have an impact on your day-to-day activities. Among the most typical ways that people are impacted are:

- The cost of living goes up. Groceries, gas, and clothes may cost more as inflation worsens a recession. When prices rise, it's harder to make ends meet, so people stick to strict budgets and spend less.

- Loss of a job or a cut in hours. When the economy is bad, companies often cut staff to save money. You could lose your job or have your hours cut.

- Having trouble finding a job. Workers have been in charge of the job market for a while now. As employers competed for a small pool of labor, they got better pay and bonuses. During a recession, competition for open employment will be tougher and it may take longer to find a new job.

How to Prepare for a Recession?

There are strategies to prepare your budget for any economic changes, regardless of whether a recession is on the horizon or not. Building your savings, reviewing your investments, and controlling your debts are important ways to prepare for unforeseen situations. Use the tried-and-true tips below to keep your budget organized at all times.

1. Reassess Your Budget Monthly

It's a good idea to keep an eye on your spending at all times, but it's crucial to do so during difficult circumstances. Make certain that every dollar is accounted for and has a purpose. You can achieve it by using a zero-based budget, which encourages deliberate spending. 

Every dollar of income goes toward a specific expense when you carefully organize your spending. For instance, you budget for expenses related to electricity, housing, food, and loan payments. But what happens if your income exceeds your bill-paying expenses? Add more saving categories (emergency fund, retirement savings etc.) You're less inclined to spend money on luxuries that can make it difficult for you to achieve your financial objectives as a result. Being proactive will allow you to create a rainy-day reserve by releasing cash flow.

2. Focus on Paying Down Your Debts

One way to get ready is to get rid of or pay off debt. This can lower your monthly bills and make it easier to deal with bumps in the road during a recession. For example, if you lose your job or work less hours because of a slow economy, having fewer or lower monthly payments will make life easier.

But pay off your debts in a smart way. It might make more sense to save for emergencies than to pay down debt quickly. If you have a good emergency fund, it might make sense to pay off your credit card debt. But if you use all of your extra cash to pay off debts, you might not be ready for surprises. In a recession, it could be helpful to have a cash cushion. Also, once your cash flow is stable, pay off debts with high interest rates first.

3. Stay Committed to Disciplined Investing

Even though it would be tempting to cease investing, it might be a wise choice to keep doing so during a recession. When markets inevitably rise, investing during a downturn can increase your long-term returns. Recognize that market turbulence, corrections, and downturns are all common market occurrences and shouldn't be reacted to. In fact, where average investors fail is when they react and try to tamper with their investments.

Speak to a financial professional to ensure you have the correct mix of investments and diversification if you are unsure how to rebalance your portfolio so that it fits your timeline and your willingness to accept financial risk. The expert financial team at Vincere Wealth can help you with any investing questions you may have. Click here to chat today!

4. Try Not to Take on Big Expenses

If you are in danger of losing your job or are dealing with other difficult financial circumstances, it may be in your best interest to keep your costs as low as possible. If your finances are affected by a recession, taking on additional substantial monthly obligations like a high car payment may make things more difficult for you.

Wrapping Up

You might not need to make changes if a recession occurs if you have a strong emergency fund and an all-weather investing strategy in place. The benefit of getting your money in order before going through a difficult moment is that you may concentrate on life's more significant pursuits and provide for your loved ones. Don't be too hard on yourself if you're still building your emergency fund because that's easier said than done if you're already struggling to make ends meet.

Check out this week's episode on “The Happy Hour Money Podcast” on All Weather Investing Strategy. This one you do not want to miss. Cheers!

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