What Would a U.S. Recession Mean for Your Money?
For more than a year, economic forecasters have been predicting the likelihood of a U.S. economic downturn amid the Federal Reserve’s efforts to curb inflation by raising interest rates. Historically, achieving a “soft landing”—controlling inflation without triggering a severe recession—has been challenging for the Fed during such periods.
However, the U.S. economy has shown remarkable resilience despite the Fed’s actions. Although GDP growth slowed in the first quarter of 2024, consumer spending remains robust. Meanwhile, inflation has decreased from its June 2022 peak of 9.1%, and the U.S. labor market continues to show signs of strength.
Since World War II, the United States has experienced 12 recessions, averaging one every 6.5 years. While numerous factors influence the U.S economy, history suggests an economic downturn is long overdue. Here’s what a potential recession might mean for your money, as well as tips and strategies to help you safeguard your financial well-being—no matter what the future holds.
What Is a Recession?
A recession is commonly marked by a decline in real Gross Domestic Product (GDP) for two consecutive quarters. However, there’s no universally recognized definition of a recession.
In the United States, the National Bureau of Economic Research (NBER) officially declares recessions. Rather than adhering to a strict rule like two consecutive quarters of GDP decline, NBER considers the depth, diffusion, and duration of an economic downturn, defining a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
Economists also consider other indicators such as unemployment rates, consumer spending, and business investment to diagnose a recession. These indicators can provide a more nuanced picture of economic health beyond what GDP figures alone can offer.
How Recessions Affect Personal Finances
Recessions inevitably affect a wide range of people, yet the extent and nature of their impact can differ significantly based on the severity and duration. Individual circumstances such as employment status, income level, and personal financial obligations also play pivotal roles in determining the financial repercussions of an economic downturn.
For business owners, self-employed individuals, and high earners, the financial effects can be diverse. Here’s a look at what a potential U.S. recession might mean for your money and how you can prepare accordingly.
Reduced Income and Cash Flow Challenges
Unemployment typically rises during recessions as companies reduce staff to cut costs or go out of business. Even if you remain employed, high earners may lose bonuses and other incentives, lowering your overall compensation.
Similarly, business owners and self-employed individuals may see their revenues decline as customers and clients cut back on spending. Fluctuations in demand can create cash flow challenges, making it harder to plan finances month-to-month.
To protect your financial health and stability, aim to have at least three to six months’ worth of living expenses saved in a highly liquid account, such as a high-yield savings account. An emergency fund serves as a crucial buffer against financial setbacks such as job loss, income reductions, or unforeseen expenses during a recession, helping you avoid the pitfalls of accruing debt or prematurely tapping into your investment accounts.
Investment and Retirement Account Losses
A recession doesn’t invariably result in significant stock market declines. However, consumers tend to reduce spending during an economic downturn, negatively impacting corporate earnings and ultimately causing stock prices to fall.
Consequently, investors may see their retirement savings and other account balances fall due to a recession. This can be especially damaging for those nearing retirement, who have limited time to recover from financial losses.
However, economic downturns can also present unique investment opportunities. Lower asset prices during market drawdowns may offer chances to buy investments at a discount, potentially enhancing long-term growth prospects.
To prepare for a potential recession, it’s prudent to assess your investment portfolio to ensure it aligns with your financial goals and risk tolerance. This step is crucial after prolonged market upswings, as your portfolio’s actual composition may drift from your initial strategy.
Furthermore, maintaining a long-term perspective and consistently contributing to your investment accounts is key. Employing a strategy such as dollar-cost averaging—investing a fixed amount at regular intervals regardless of market conditions—can help smooth out purchase prices and improve overall investment outcomes by mitigating the risks associated with attempting to time the market and emotional decision-making.
Access to Credit
During recessions, banks and financial institutions often tighten their lending standards. Tighter credit conditions can make it harder to secure home loans, auto loans, or other lines of credit, potentially impacting your ability to make large purchases or effectively manage expenses.
The tightening of credit can also alter the terms and interest rates of existing loans and lines of credit. Financial institutions might adjust these parameters to mitigate risk, potentially increasing your overall borrowing costs.
To protect your financial well-being in anticipation of potentially tighter lending standards, focus on paying down high-interest debts, such as credit card balances, personal loans, or any variable-rate loans. Reducing these debts can decrease your financial obligations and interest costs, which is crucial during economic downturns when cash flow might be unpredictable.
Moreover, maintaining a strong credit profile and solid financial records can improve your chances of securing credit even if lending standards tighten. If interest rates decline, you may also want to consider refinancing mortgages or other loans to reduce your monthly payments and total interest cost over time, freeing up cash for other essential uses.
Spending and Lifestyle Changes
The combination of economic uncertainty and reduced disposable income during a recession generally compels consumers to revise their spending habits, prioritizing essentials over luxuries.
These changes, while financially prudent, can affect your lifestyle and overall quality of life in an economic downturn. For example, decreasing your spending can lead to downgrading or canceling vacations, dining out less frequently, or postponing significant purchases like vehicles or home renovations.
To better prepare for and mitigate these challenges, be sure to carefully examine your budget to prioritize essential expenses and identify areas where you can cut back if necessary. If the risk of losing your income in a recession is particularly high, try to avoid taking on new debts, especially for non-essential expenses.
It’s also a good idea to build or maintain an emergency fund that covers at least three to six months of living expenses. By proactively taking these steps, you can strengthen your financial position and feel more secure during an economic downturn.
Tax Planning Opportunities
During economic downturns, high-earning professionals might find that their taxable income decreases due to a reduction in bonuses, commissions, or overall business revenue. While a reduction in income can present challenges, it also opens up several opportunities for strategic tax planning that can help mitigate the financial impact and even set the stage for future tax efficiency.
To take advantage of these opportunities, proactive financial planning is essential. A trusted financial professional can help ensure you’re optimizing the tax deductions and credits available to you, minimizing your overall tax liability.
An experienced advisor can also recommend and implement strategies such as a Roth conversion, which can help lower your tax bill in the future. By taking steps to manage your tax obligations and make savvy financial decisions, you can navigate the immediate financial challenges of a recession while positioning yourself for long-term success as the economy recovers.
TrueNorth Wealth is here to help.
While economic downturns indeed pose challenges, they also offer valuable opportunities to strengthen your financial foundation and resilience. By understanding the financial implications of a recession and preparing proactively, you can effectively manage economic uncertainties and emerge financially stable.
If you lack a financial plan or are seeking further guidance to safeguard your financial well-being, TrueNorth Wealth is here to help. Our team of fiduciary CFP® professionals offers personalized advice tailored to your unique financial circumstances and objectives, helping you to optimize your financial outcomes in good times and bad.
TrueNorth Wealth is among the top Wealth Management firms in Utah and Idaho, with offices in Salt Lake City, Logan, St. George, and Boise. At TrueNorth Wealth, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by pairing our clients with a dedicated CFP® professional backed by an incredible team.
For our team at TrueNorth, it’s about so much more than money. It’s about serving families all across Utah and helping them achieve freedom and flexibility in their lives. To learn more or schedule a no-cost consultation, visit our website at TrueNorth Wealth or call (801) 316-1875.
