Are your finances prepared for a recession?
In his Summer Statement, the Chancellor announced how he intends to minimise the economic consequences of the expected recession.
Should you be making sure that you are more resilient financially now to prepare for the expected recession?
Should you be holding more of your portfolio in cash to give you that extra resilience?
In previous posts, we have concluded that the size of your emergency fund should depend on:
-Your stage of life
-The amount which makes you feel comfortable.
-Your access and attitude to borrowing
The first two shouldn’t change as a result of a recession, and, if you prefer not to use borrowing in an emergency, that part of the calculation shouldn’t change either.
If you have been happy to borrow in the past, you might find that it’s not so easy to borrow in the future – either because of general economic factors or because your personal situation has made it more difficult to access credit.
So, it would be easy to conclude that you shouldn’t make any changes to the size of your emergency fund in the face of a looming recession.
However, we should consider how a recession could affect personal finances. The biggest threat which a recession poses is to earned income.
If you have retired, and rely on investment income, your Financial Planner should have allowed for recessions when calculating how much you could safely withdraw from your portfolio (if not, you need to find a new planner), so your income shouldn’t be affected.
But, if a recession is coming, and you are working, it’s a good idea to work out how you would cope with the double whammy of a financial emergency at the same time as a reduction or temporary loss of income.
The research tells us that, on average, we experience more than one unexpected cost (i.e. financial emergency) a year, and there’s no reason to imagine that will change in a recession.
I’m afraid you’re just as likely to need emergency dental work during a recession as you are in the good times!
Remember that the biggest causes of financial emergencies are cars (and the more cars you are responsible for, the more likely it is that you’ll have to pay for an emergency), properties, family health and pets.
Assuming that you have planned well, your emergency fund should be able to cope with an unexpected cost when it arises. But the problem is that the emergency fund might need replenishing after you’ve paid for that unexpected cost.
And, if you don’t have a large enough fund, you may begin to feel financially vulnerable.
The answer isn’t to have a larger emergency fund though.
The answer is to have a plan in place in case you need to spend some of your emergency fund at a time when your income has taken a hit. So, rather than feeling financially vulnerable, and worrying about it, you can simply enact the plan you made in the good times and get on with your life.
The emergency plan may be that you switch to paying interest only on your mortgage for some time, or you stop saving temporarily – the answer will be different for everyone – but the important thing is to have the plan in place.
It’s best to write it down as none of us is great at remembering what to do in times of stress.
If you’d like some help to prepare your finances for a recession and to have a Financial Plan which will tell you how to deal with those unexpected costs in the bad times, feel free to contact us.