The decisions made by people during economic downturns can haunt them or reward them for decades to come. The decisions you make during a recession are a lot more important than your decisions during a booming economy.
During an economic downturn, especially during an outright recession, it is essential to avoid undue risks that could hurt your financial goals. During a recession, the probability of loan defaults, business failures, and bankruptcies increases drastically. There are some financial habits that will ensure you never find yourself in a bad financial situation. Just as importantly, there are decisions that you MUST AVOID at all costs during a recession.
1. Cosigning a Lease or a Loan
During a recession, many people will have a harder time getting a loan as the standards for getting a loan will be much higher. Let’s take a step back to understand why getting a loan during a recession is much harder. During a recession, the FED lowers interest rates to encourage people to borrow money and stimulate the economy. However, the chances of people defaulting on these low-interest rates are much higher due to the high possibility of job loss. Therefore, banks are much stricter about whom they will loan money to.
If you have a friend or family member who doesn’t have a stable financial future, they will require a co-signer for the loan. I suggest you think long and hard before you even consider being a co-signer. Remember, there is a reason why the bank is not willing to give that person a loan.
Your friend or family member may have the best of intentions. They might not intend on defaulting on that loan, but a lot of situations are NOT under an individual’s control during a recession. People lose jobs during a recession at no fault of their own. Once booming businesses can drastically slow down and no longer be profitable during a recession. In these scenarios, you are on the hook for paying back those loans as the co-signer.
The best decision for yourself is to NEVER cosign a lease during a recession. However, you might be in a situation where you do want to help your friend or family member. In this case, there are some less risky alternatives.
What you should do instead:
- Instead of becoming a cosigner during a recession, consider helping your family member or friend with a personal loan or help with the down payment.
- Help them find a different lender that will loan them money without a cosigner if they put down a higher down payment.
Getting out of a cosigner agreement is extremely hard once signed. I will say it again! Think 10 times before becoming a co-signer.
2. Slack Off at Work
An economic downturn is NOT the time to take your job for granted, especially if it’s your only source of income. This doesn’t mean you should work extra hours and be fearful of losing your job. It just means not giving any reasons to your workplace for letting you go (basically just doing your job). This doesn’t necessarily mean you won’t be laid off, it just means you are doing everything under your control. Many times, there isn’t much you can do to protect yourself from a layoff.
Many people may think getting laid off is not that bad as they can apply for unemployment while looking for another job. However, research shows that people laid off during a recession are highly likely to be unemployed for long periods of time. Of the people that were laid off during the Great Recession of 2008, only 30-40% of the people were employed again by 2010 according to Investopedia. It’s in your best interest to retain your current job during a recession. The job market can be brutal during a recession; you DO NOT want to be looking for a new job during that time.
What you should do instead:
- Always keep your resume ready, even if you don’t intend on changing jobs.
- Keep an ongoing list of all tasks you do. (You never know when you might be asked to report this information to your manager)
- Make yourself irreplaceable at work. This means taking on tasks that not many other people know how to do. It also means keeping yourself knowledgeable about all current projects.
3. Maintain an Unsustainable Lifestyle
People that catch themselves unprepared during a recession are the people that maintain the same extravagant lifestyle during a recession. Even when the entire economy is going south, some people just don’t make any changes in their lifestyle. They keep going to sporting events as they were and spending money on bars and restaurants as they were. They keep going on the same lavish vacations they are used to.
There are reasons to downsize your lifestyle during an economic downturn even if your income is not yet affected by the recession. The main reason is to pad up your emergency fund to prepare for the worst. If you do end up losing your job, it will be more manageable if you are already used to living below your means. Additionally, you can feel safe enough to take your time with finding a new job if you have a hefty emergency fund lined up.
Another reason is the opportunity cost of not using the money in better ways. An economic downturn is financially devastating for most people but very fruitful for those with cash on hand for seizing profitable opportunities. The money you save from downsizing your lifestyle should be used for investing in assets.
How to downsize your lifestyle:
- Consider selling or downsizing any liabilities that drain resources every month such as a boat or an expensive car
- Cut down on frivolous spending such as eating at restaurants and bars or any costly entertainment.
- Replace expensive vacations with local trips or more nature-based trips
- Create a budget and stick to it
4. Panic
When people see the economy come crashing down, their first instinct is to do something quickly (which they usually end up regretting later on). When the stock market goes down ~5% every single day, your first instinct will be to sell your investment before it goes down any further. Ask anyone that has lived through previous recessions, and they will tell you why it’s a bad idea.
Panic generally leads to you making rash decisions that cannot be undone. The rash decisions made during an economic downturn can result in financial setbacks that haunt you for decades.
When you are in a tough situation, taking any action feels better than doing nothing. You must resist this urge when you see all things you have tried to build over the years starting to fall apart (I am of course being a little dramatic here, but this was actually a reality for many during the Great Recession of 2008).
Imagine! Your investments in the stock market are cut in half. The house you bought a year ago is now worth 70% of what you bought it for. Even at this point, it just doesn’t seem like things are going to get any better any time soon. You will want to do something right away to make yourself feel better and have some financial security. Any decisions you make during this panic mode will most likely be the wrong decision.
What You Should Do Instead:
- Remind yourself that in some situations, no action is the best action
- Remind yourself that all recessions are followed by an economic recovery
- Know that this is temporary and things will get better in a couple of years
- Keep calm, stay level-headed and make decisions objectively
- Think about the long-term effects of your decisions
- Do not sell any of your investments
5. Ignore Your Budget
Budgets are a great way to maintain awareness of where your money is going every month. Every person that is good with money practices budgeting in form or another. Even if many people might not formally use a budget to manage their money, they have a money mentality that’s in line with the principles of budgeting. Budgets help you maintain a moderate lifestyle regardless of the state of the economy.
Budgeting habits will help you ensure you don’t spend more than you can afford during an economic downturn. They help you save and grow your money during an economic boom. Budgets are generally based on a certain percentage of one’s net income. Let’s say you have to downsize your job during a recession, budgeting habits will help you downsize your lifestyle according to your new income.
Those who don’t budget don’t even really think about adjusting their lifestyle when their income changes or when the economic climate changes. Ignoring your budget is not a good idea, especially during a recession.
6. Taking Out an Adjustable Rate Mortgage
If you know anyone that lived through the Great Recession, they can tell you why it’s a horrible idea to get an adjustable-rate mortgage. These loans were one of the biggest reasons behind the real estate collapse of 2008.
Adjustable rate mortgages start with lower interest rates for the first few years, so the monthly mortgage payment is low. However, these rates change over time (typically, they increase). Many people find themselves not being able to afford the new (higher) monthly payment. Don’t let yourself be in that situation. The combination of raising interest rates and decreasing income during a recession could end up making you homeless.
Imagine you buy a house because you can afford $1800/month in mortgage payments, but that payment changes to $2600/month in two years. That can be a drastic change to manage if you live on a tight budget. This was the reality for many people that took out adjustable-rate mortgages during the Great Recession of 2008.
What You Should Do Instead:
Instead of getting an adjustable-rate mortgage, get a fixed-rate mortgage even if it might have a higher interest rate. This way, you will know exactly what your mortgage payment will be regardless of the state of the economy. Once you have some portion of your mortgage paid off, you will also have the option to refinance your mortgage with a lower interest rate in the future. A fixed-rate mortgage with a higher interest rate is a much better choice than any adjustable-rate mortgage in which you can not gauge what your future mortgage payments might look like.
7. Be Caught Unprepared
When all indicators suggest that a recession is approaching, think of the worst-case scenarios. The next move is to start preparing for these scenarios. Some of the common scenarios are:
- Losing your job
- Investments losing money
- The stock market being down
- Family members losing their jobs
- Not being able to pay monthly expenses
Some of the common solutions to these scenarios are:
- Keep maintaining your savings account
- Make sure you have 6 months’ expenses in an emergency fund.
- Make yourself essential at work
- Acquire new skills or improve your existing skills
The objective is not to let any life events catch you unprepared. The best way to ensure you can power through any adversities during a recession is to always live below your means and have a backup plan.
Hopefully, you feel financially educated enough to not do any of the things listed in this article once the inevitable recession is on the horizon. Let me know if you’d like for me to give more examples or expand upon any of the topics discussed above.