If you’ve been following the latest financial news, it might look like the U.S. economic expansion is nearing its untimely end.
The 2-year, 10-year Treasury yield flashed recession-red lights Aug. 14, after it inverted for the first time since before the financial crisis. That prompted a swift market sell-off, with investors already worried about trade tensions between the U.S. and China, as well as a slowdown in business investment, manufacturing and growth around the globe.
Why predicting recessions is difficult
But as recession fears return to scare financial markets and everyday Americans alike, it casts a spotlight on just how complicated predicting downturns are — even for those who are trained to identify them.
A working research paper from March 2018 by economists at the International Monetary Fund (IMF) — Zidong An, Joao Tovar Jalles and Prakash Loungani — found that economists don’t necessarily have a strong track record for predicting downturns before they start.
The IMF surveys forecasters in the private sector twice a year, in April and October. Out of the past 153 recessions in 63 countries between 1992 and 2014, only five were predicted in the April survey, a year before those recessions. The failure to forecast a recession was also a much more common phenomenon than falsely identifying one, the IMF found.
“Some people say economists exist to make weather forecasters look good,” says Tara Sinclair, an economics professor at George Washington University and a senior fellow at Indeed’s Hiring Lab. “At least they can look at the planet, and they can dial satellites and information. They can see the clouds coming over.”
“But the complexity of the macro economy is such that we haven’t yet figured out a clear, causal model of how things work,” she says. “We can’t predict with any kind of confidence what’s going to happen, particularly when things are changing dramatically.”
Expert tips to help make your finances recession proof
Still, if the U.S. economy is keeping you up at night, it’s never too soon to ensure that your finances are well-equipped to weather any storm.
Here are seven tips, as recommended by experts.
1. Pay down debt
It’s crucial that you pay down any outstanding debt — more specifically, high-cost debt, such as your credit card balance — to create some breathing room in your budget.
Often, economic downturns lead to job loss. If you’re worried about job security, paying off your obligations might bring you more peace of mind.
Prioritize credit card debt, then turn to other types of loans, such as mortgages or auto loans. Student loans, however, have more favorable provisions, which makes paying them off less of an urgency, says Greg McBride, CFA, Bankrate’s chief financial analyst.
But even if you’re not worried about losing your job in a downturn, it’s still good financial practice. A March 2019 Bankrate survey found that 13 percent of Americans aren’t saving more because of the amount of debt that they owe.
“Regardless of where we are in a market cycle, prioritize eliminating high-interest rate debt no matter what,” says Lauren Anastasio, CFP, a wealth adviser at SoFi, a personal finance company. “Being in a position where you’ve eliminated those types of high-cost obligations allows you to better prepare for other things financially. The more you’re able to put aside for saving and the less debt you have, it’s going to be available to you in case of an emergency.”
Use Bankrate’s tools to calculate a debt-payoff plan or take advantage of balance-transfer credit cards with zero percent intro APRs. These offers disappeared in 2008, Anastasio says, so they’re likely not going to be around when the next downturn comes.
2. Boost emergency savings
Job loss can also make it difficult for Americans to pay their day-to-day expenses.
Beefing up your emergency fund — that is, the pool of cash that you reserve specifically for events like downturns — can make it possible for you to still afford your necessities while you search for a new position.
Even if you’re paying down debt, it’s important that you prioritize saving. Focus first on loading up your emergency fund with one month’s worth of living expenses. After that, pay off your debt, and then focus on building up a reserve of three-to-six months worth of funds, Anastasio says.
“Everyone needs to have a cash cushion, even while they’re attempting to pay off high-interest rate debt,” Anastasio says. “It’s imperative because, if an emergency arises and you’re putting every dollar toward eliminating debt, you have no choice but to go back to credit cards to cover the expense.”
A high-yield savings account can help you earn more on the money you stash away. Shop around for the best account that suits your needs and lifestyle.
3. Identify ways to cut back
Before a downturn begins, it’s a good idea to go through your monthly expenses. Identify which items are discretionary — services or items you don’t need — and which items are a necessity. The discretionary items are most likely ones that you can either eliminate now or in the future, McBride says.
“Certainly your starting point would be the discretionary items — subscription services or even just spending patterns,” McBride says. “Dinners out or nights out at the bar with friends can seriously add up over time.”
4. Live within your means
Experts typically recommend spending no more than 30 percent of your net income (that is, earnings after taxes) on discretionary items. It’s a good idea to create a monthly budget to ensure that you’re living within your means and not overspending.
“You have to pay your rent; you have to pay your car insurance; you have to eat to live. Your groceries, your utilities — those are all going to be essential expenses,” Anastasio says.
“But dining out, vacations, cable — anything that you would potentially consider a luxury or a lifestyle expense — that’s discretionary spending.”
5. Focus on the long haul
After addressing your emergency savings and paying off your debt, your next worry when thinking about a downturn might be about your investments. The thought of the markets plummeting might make you fearful that you’ve lost all of your earnings after years of hard work.
Changing your strategy, however, would be the worst thing you could do, McBride says.
“It will take a tough stomach, because in a recession a stock market will easily fall 30 to 40 percent, peak to trough, but making regular contributions and reinvesting all of the distributions will make those market gyrations work to your benefit,” McBride says. “A recession is a tremendous buying opportunity.”
That goes for all individuals, whether you’re 20 or two years away from retiring, he says. If you’re planning to retire in the next few years, when a recession looks like it could be coming, it might be a good idea to have your first few years of withdrawals already in cash. But don’t shy away from equities in your portfolio. Those are often where you’ll get the most returns that provide inflation protection, he says.
“Do not make changes that jeopardize your long-term financial security based on short-term economic events,” McBride says. “Even for someone who is on the cusp of retirement, retirement is going to last 25 to 30 years. A recession is going to last a year.”
6. Identify your risk tolerance
Still, it might not be a bad idea to work with a financial adviser on identifying your risk profile, Anastasio says. That includes identifying your risk tolerance — or how much risk you can afford to withstand — and your risk appetite — or the amount of risk you’re willing to take on.
Risk suitability is also another important factor, Anastasio says, a component that’s based on when someone plans on cashing out their investments. If you’re going to change your investing strategy at all, let it be based on this, she says.
“The sooner we expect someone to use the money, that’s where they’re going to need to be more conservative with their options: high-yield savings accounts, CDs,” Anastasio says. “On the other end of the spectrum, when we’re looking to invest for eight to 10 years or longer, that’s when it tends to be more appropriate to be invested in equities or stocks as a whole.”
7. Continue your education and build up skills
But to recession-proof your life, one of the best investments you can make is pursuing an education, Indeed’s Sinclair says. During recessions, the unemployment rate for those with a bachelor’s degree or higher is much lower than for those who have a high school education or less.
“Economists are always emphasizing the importance of education,” Sinclair says. “That’s something, even if you can’t build up a financial buffer, focusing on making sure that you have some training and skills that are broadly going to be employable is really crucial.”
Plan for the unexpected when it comes to the economy
To put it simply, spotting a recession before it starts is a difficult task. Information is often revised, updated and corrected. It’s released with a lag. Even so, developments shift rapidly.
Officials on the Federal Reserve, for example, penciled in two rate hikes for 2019 back in December. But in a move that would’ve been unforeseen at the time, the Fed in July of 2019 cut rates for the first time in more than a decade.
Recessions are typically defined as a drop in output or a slowdown in growth. Though most economists would lump the two causes of recessions into supply shocks or demand shocks, each of the past 33 recessions (as tracked by the National Bureau of Economic Research’s Business Cycle Dating Committee) have been caused by something a little different, Sinclair says.
Sometimes the U.S. central bank has tightened interest rates too fast and too far, as it did during the July 1981 to November 1982 recession, when the Fed under Chair Paul Volcker hiked borrowing costs to fight skyrocketing inflation. Others have been caused by asset bubbles, such as the financial crisis and the 2007-2009 recession, the worst since the Great Depression.
“Obviously, if recessions were easily predictable and preventable, we’d expect policymakers to be doing just that,” Sinclair says. “If we think back to 2007, many people asked, ‘How did we not see it coming?’ But that’s the nature of recessions. They are these terrible things that we can’t predict.”
Even so, economies don’t always react to shocks in the same way. Markets panicked after the Fed in December hiked rates for the fourth time in 2018, fearing that too much monetary policy tightening would spur a downturn. The markets, however, bounced back in 2019, flirting with new highs.
It’s hard to predict the future when you’re using the past as a guide, Sinclair says.
“Our economy is changing so dramatically,” according to Sinclair. “There’s many different sources that can lead to a recession, and it tends to be that when we look out for the next one, we’re looking for the same things that caused the recession rather than recognizing that there’s a new source.”
But you can take solace in the fact that economists are generally much better at knowing whether the U.S. economy is in a recession, Sinclair says. Even though predicting them is close to impossible, you won’t have to wait long before knowing that the U.S. economy is in one.
“Basically, when people ask me, ‘Are we in a recession?’ We are not,” Sinclair says. “Are we going to be in a recession in the next month? I don’t know. … To be able to look forward into the future — we don’t have that crystal ball.”
But regardless of whether the storm is on the horizon, it’s always a good time to make sure your financial portfolio is prepared, Anastasio says.
“I don’t think there’s ever a bad time to evaluate their finances and check in with themselves,” Anastasio says. “If someone personally feels nervous that there’s change on the horizon, it’s always a good time to say, ‘What can I do personally to put myself in a stronger financial position, so I can sleep better at night when the time comes.’”
- Watch for these 6 indicators to know when a recession could be on the horizon
- Should fear of the next recession keep you from buying a home
- 8 best low-risk investments for 2019