There’s a lot of talk lately that we're heading into a recession. some say we are, some say we're not, there are several possible scenarios – it’s too early to tell. Now is a good time to start thinking about the possibility and the impact it will have on your money, and how you can prepare if it does happen.
A recession happens when there's a decline in economic activity causing GDP (gross domestic product) to fall for several months. This can then lead to further reduced consumption and investment, or to some job losses. Since 1970, in Canada, there have been five recessions and they last between three to nine months on average.
The recessions in the early 1980s and 1990s for example were caused by interest rate hikes that were introduced to contain inflation, which then led to economic slowdowns. Other factors can include:
A significant and lasting shock to commodity prices
A financial bubble bursting
Corporate debt overextension
Loss of confidence in the economy
Wars, pandemics, etc.
If we are headed for a recession, some of the contributing factors this time could be the pandemic, the war in Ukraine, supply chain problems, and very low-interest rates, which have all fuelled inflation. In order to combat inflation, we are seeing rising interest rates similar to the '80s and '90s which could then lead to an economic slowdown.
How would a recession impact you?
The effects of a recession can vary depending on each individual’s financial situation.
If you have investments, you've likely seen a drop in their value this year. This fluctuation is normal, but a prolonged drop in values can affect your savings, depending on the risk level of your investments and the diversification of your portfolio.
You may need to review and adjust spending.
Though job losses are still possible, with the current labour shortage, the risk is lower than in past recessions.
Even though interest rates have increased, they remain historically low, and low interest rates help to support the economy.
If there is a change in your household’s economic situation, you may be tempted to make changes to your financial plan by reducing, or stopping your savings. As you will see below, however, this could have long-term consequences for your future.
Can a recession be a good thing?
For some people, recessions can be difficult while they last, but they are temporary. For others, recessions can lead to new opportunities. The key to not just surviving, but also thriving during and after a recession depends on how well prepared you are.
People who are invested in the stock market for the long term can also benefit when the economy recovers. Investing a fixed amount regularly, or Dollar Cost Averaging is one way to take advantage of these lower valuations made possible by recessions.
Historically, following an established plan and staying invested for the long term is always a wise strategy.
What should you do?
While every situation is different, certain strategies are relevant for most people, even when the economy shows fewer encouraging signs. Here are some things you can do right now to prepare for the possibility of an economic slowdown:
Have a financial plan to help you stay on course, and how to deal with potential obstacles
Stay on track with your savings plan, and if possible increase your Dollar Cost Averaging amount to take advantage of buying opportunities
Keep in mind the risks of selling investments at a loss when markets are down
Build up a Cash Reserve, if you don’t already have one.
Reduce the amount of high-interest debt you are carrying.
In conclusion, for the unprepared, the possibility of a recession might strike fear. For the prepared, it might be seen as an opportunity. The best time to prepare is before it happens by creating your own plan to not just survive but thrive.