By Nick Strain
Warner Bros. / Courtesy Everett Collection
According to a recent survey by the National Association for Business Economics, seven out of 10 economists expect a recession by the end of 2021.
Even the savviest investors worry about not having enough cash on hand to cover basic expenses during a recession — let alone those who have their entire nest egg wrapped up in a volatile market. That reasonable anxiety can prompt 401(k) participants to decrease their contributions or even cash out on their retirement savings entirely.
However, the long-term harm that a panicky move may have on their ability to retire outweighs any short-term benefits.
An economic downturn may tempt investors to put even less into retirement savings while waiting for a bull market to return. On the surface, it seems like this strategy protects savings. During the last recession, personal savings as a percentage of disposal income fell from 6.4% to 3.7% between December 2008 and January 2009. With concerns about another recession growing, many investors might consider cashing out on savings in an attempt to avoid similar losses. However, because it is almost impossible to time the market, this approach is likely to backfire, further delaying their ability to save and pushing the retirement date back. Staying steady and continuing contributions during a recession is necessary to grow savings and have a solid financial footing in retirement, even just by maintaining an employer match.
Preparing for a recession
The first and most practical step to prepare for a recession is to put aside an emergency fund. If you don’t already have three to six months of living expenses in the bank, now is the time to start saving. With an emergency fund in place, you can begin to reduce or maintain current expenses wherever possible while avoiding any unneeded costs. While building an emergency fund, it’s important to consider the timing of major purchases like a car or a house. Those who rent should seek out more affordable accommodations, or at least avoid taking on higher rent if possible. With a recession looming, it is not a good time to take on additional debt.
An effective strategy for reducing expenses is putting disposable income toward paying down existing debt. Examples of disposable income include an end of year bonus or inheritance. You’ll want to put these funds toward paying down credit card debt, mortgages, or car payments while the market is strong. It can be much harder to keep up with these payments during a recession, so get ahead now.
Cutting back on splurges
There’s no need to go cold turkey, but making small incremental decisions and effective choices all add up. You work hard and want to be able to enjoy your life — you’re entitled to that — but make sure you are saving enough on the back-end to make up for any potential market downturn.
Find little ways to save money. Go on vacation, but don’t go on an international trip — go within the U.S. and travel during off-times, where you’ll save on airfare. Instead of buying a new car, purchase a “nearly new” used car. For example, if you spent $100 less a month on your car payment, ate out once less a week ($50 a week = $200 a month), and spent $200 a month less in entertainment, you would save $500 a month. That’s $6,000 a year. These kinds of sacrifices are doable for most people.
A second strategy for saving involves using new technology or trends to find new ways to save. Here are a few examples. You could cut cable and only pay for Netflix /zigman2/quotes/202353025/composite NFLX +0.31% and Wi-Fi — better yet, if you buy your own Wi-Fi router you’ll save the $10 renting one from the cable company every month. It’s an upfront cost now that will pay off in the long run.
For online shopping, use web-based add-ons like Honey to make sure you’re taking advantage of any promo codes available. If your big splurge is taking that once-a-year big vacation, strategize using the right credit card to maximize your points for travel. To save on gas and car maintenance costs, negotiate to work from home at least a few days a week. Finally, to save on health care costs, use goodrx.com to find the cheapest pharmacy to fill a prescription.
Pitfalls to avoid
Cashing out or making significant reductions to retirement savings contributions is the worst mistake you can make during a recession.