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How to prepare for a recession

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A recession looked all but inevitable last year as inflation hit a 40-year high, consumer spending tapered, interest rates surged, and Wall Street had its worst year since 2008. Yet, employment remains strong, and inflation is (finally) showing signs of easing — bolstered by cheaper gas, supply chain improvements, and smaller profit margins at many retailers.

Nevertheless, it’s too early to declare victory on inflation, and the possibility of a recession still looms — so it’s a good idea to prepare for one, just in case. Here are tips for prepping your finances, from budgeting to earning a little extra cash in an interest-paying savings account.

A budget helps you track where your money goes each month to ensure you have enough money to cover your bills. Budgets also make it easier to achieve your financial goals, whether saving for a down payment on a home or starting a new business. Apps like Mint and YNAB make it easy to create a budget, but you can make your own using a spreadsheet or pencil and paper. While there are numerous approaches to budgeting, here’s the basic method:

  1. Tally your monthly income. Include money from paychecks, freelance gigs, self-employment, and payments you receive like child support and monthly benefits.

  2. Tally your monthly expenses. Typical expenses include housing (rent or mortgage), debt payments, utilities, insurance, food, transportation, childcare, healthcare, travel, memberships, and entertainment. Consider separating fixed expenses (such as a monthly car payment) from variable expenses (like groceries).

  3. Subtract your expenses from your income. If it’s more than zero, you have some wiggle room in your budget and can decide if you’d like to spend, save, or invest the extra money. If it’s less than zero, you’re spending more than you make, so you’ll need to find a way to earn more or spend less. A good place to start is to curb spending on things you don’t need (like a streaming service you rarely use).

  4. Stay on track. Review your budget regularly to make sure you’re staying on track. Adjust your budget when you get a raise (or pick up an extra gig), your expenses change, or you reach a financial goal — and are ready to save for a new one.

Your emergency fund should be kept safe (i.e., not somewhere risky like crypto) and accessible — meaning, a place where you can tap the funds immediately should you need them. High-yield savings accounts are good options since they offer competitive interest rates, are easy to access, and are FDIC-insured (up to $250,000 per depositor, per account ownership category). Accounts held in credit unions have similar protection through the National Credit Union Share Insurance Fund (NCUSIF). 

A certificate of deposit (CD) is another option. Like savings accounts, CDs are insured by the FDIC or NCUSIF, so your money will be safe. However, you’ll owe a penalty if you withdraw funds before the CD matures — unless you have a liquid CD (aka “no-penalty CD”). CDs generally pay a higher rate than high-yield savings accounts to compensate for their lack of flexibility. So, a CD might make financial sense if you can manage to have your cash “locked up” for 6, 12, 24, or 36 months (the standard CD terms).  

According to Bankrate, the best savings account rates as of Jan. 24 are as high as 4.00%, while CDs are paying up to 4.50% (based on a minimum $1,000 deposit).

Debt can cost hundreds or thousands of dollars each month in interest charges. If you add to your debt and make only the minimum payments, the situation can quickly become unmanageable.

There are two basic strategies for tackling debt:

  1. Avalanche method. This approach focuses on paying off your highest interest rate debt because it costs the most. Make the minimum payment (on time) on all your bills and put any extra money toward your highest-interest debt — like credit card and student loan debt. Once you pay it off, you can tackle the next debt on your list. This method can feel like a slow burn (it takes a while to see any progress), but it can save you money in the long run.

  2. Snowball method: With this approach, you continue making minimum payments on all your debts, but any extra cash goes toward your smallest debt. Once that’s paid off, use the freed-up money (what you were paying on the previous debt) to pay down your next-smallest debt — and so on. Unlike the avalanche method, you’ll see progress quickly, which can be motivating. But, it will likely cost more in the long run since it delays paying off larger or more expensive debts.

The sooner you can pay down debt, the more you’ll save in interest charges — and the more cash you’ll have in your budget to spend, save, or invest.   

Tip: If you’re having trouble making minimum payments, your lender(s) might be willing to work with you. Contact them, explain your situation, and discuss your options. Your lender might be able to extend your due date, arrange a payment plan, lower your interest rate, or reduce (or waive) any fees — making it easier to get back on track. 

An emergency fund is an excellent way to prepare for the unexpected: a medical bill, a fender bender, home repairs, or a sudden loss of income. Without savings to cover these surprise expenses, you might have to rely on high-interest credit cards or loans, which can lead to debt that’s hard to pay down.

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