How Does A Recession Affect Your Personal Finances?

What is a recession?

A recession is generally defined as two consecutive quarters of decline in a country’s real gross domestic product (GDP). A functioning economy sees money flowing freely and at a stable pace, but during a recession, economic movement slows down and stability is tipped out of balance. The government’s job is to restore balance, by stimulating or slowing spending and stabilizing prices. 

What are the impacts of a recession?

The impacts of a recession can become a self-fulfilling cycle. If business productivity is reduced, people may lose their jobs or miss out on pay increases, which has a knock-on effect on consumer spending, which then affects business profitability, and so the cycle continues again. Psychologically, the negativity surrounding a recession creates a lot of fear, and our natural human instincts kick in. First some people panic sell investments at a loss, and then others copy, which creates further ripple effects throughout the economy. 

How does a recession impact me?

Here are some important ways a recession could impact you as an individual:

Job security

Economic uncertainty can leave businesses vulnerable. If demand for products and services is reduced, business revenues can suffer, leaving them with no choice but to cut costs — which can be in the form of redundancies and layoffs. Depending on the cause of the recession, certain jobs or industries may become more broadly unstable, making it harder to find another job.

Higher rates on lending

Governments control the central cash rate that informs the interest rates that banks and financial institutions pass onto customers. When in a recession, interest rates may increase as the government attempts to stabilize the economy, which can mean borrowing is more expensive. This means higher repayments on loans and mortgages, leading to less disposable income for individuals with loans to repay.

Higher rates on savings

The flip side of that is the interest rates on savings accounts may increase, meaning your money is earning more money. The fluctuation of interest rates informs consumer behavior by disincentivizing borrowing and spending, and incentivizing saving.

Volatility in investments

If you hold investments in stocks or funds, the value of these may decrease during a recession. This can happen as a result of reduced business productivity and profitability, and greater threats to previously high-performing sectors. However, market dips can provide opportunities to those who continue to invest through the downturn rather than selling at a loss.

Inflation 

During a recession, the cost of goods and services may increase at a faster rate than usual due to inflation. Higher inflation means the value of money decreases faster than it should, and can cause the cost of living to rise faster than wages. 

How do I prepare for a recession?

It’s always wise to be prepared for a recession or any other financial difficulty, whether caused by broader external factors or personal life events. Here are some tips on preparing yourself for financial downturns.

• Build up an emergency fund

An emergency fund is one of the best catch-all financial protections you can prioritize. Saving up 3-6 months’ worth of living expenses can give you the breathing space you need to deal with job losses or rising costs.

• Plan for the worst-case scenario

Acceptance is powerful in handling a crisis, so planning ahead for your worst-case scenario can help you better manage financial adversity. Take some time to sit down with your finances, assess how much security you have, and what your plan of action could be if you lost your job or if your expenses rose sharply. Identifying a crisis plan ahead of a crisis occurring can be incredibly powerful. 

• Trim the fat on your living expenses

… or at least identify areas you could cut back if necessary. Getting clear on your income and expenses and understanding areas you have the flexibility to cut back can help you know where to turn if things get rocky. Whether you could shop smarter with your groceries or ditch your subscriptions and memberships, knowing which strings to pull can take a huge emotional and financial weight off. 

Visibility over your financial situation puts you in a strong position to adapt to unexpected events like recessions. PocketSmith is the global personal finance software that gives you total customizable control over your finances, and helps you feel prepared for life’s ups and downs.

Emma Edwards is a finance copywriter and blogger, on a mission to humanize the financial services industry by creating meaningful content that’s accessible and empowering. You’ll find her penning money tips at her blog, The Broke Generation, sharing financial insights on Instagram, or injecting life into content for her business clients.