Hopefully, we’re not headed into another recession anytime in the near future, but with accelerating inflation and concern about the cost of living, it’s a good idea to be prepared for whatever the future may have in store.

Readying your finances for an economic downturn is really about five things:

1. Knowing your financial situation
2. Creating a budget
3. Limiting your spending
4. Building an emergency fund
5. Paying off high-interest debts

Let’s dive into each of these.

1. Know your financial situation

When we work with clients on better managing income and cash flow, we start by mapping out their current cash flow. This involves choosing a time period and tracking income and expenses over that period.

But forming an accurate picture of your financial situation is about more than just knowing how much cash you have on hand or how much you’ll make this month (though both of those are important as well).

Ask yourself questions like:

● How much do you have in savings and investments?
● How much debt do you have and what are the interest rates?
● What are your regular monthly expenses and how many of those are essential?

2. Create a budget

Another thing we help our clients do is set targets for different expense categories: such as food, transportation, utilities, and entertainment. Financial experts usually recommend dividing your income into:

● 50% essentials (food, rent, healthcare, etc.)
● 30% nonessentials (entertainment, eating out, travel, etc.)
● 20% savings (emergency fund, investments, savings account, etc.)

Whether or not your budget lines up with that perfectly will largely depend on how much you make compared to how expensive of an area you live in, but if you can create a budget that’s more or less along those lines, you’ll do well—and having a solid budget in place can help you both build your emergency fund before a recession hits, and prioritize spending after.

3. Limit your spending

Creating a budget is often the easy part: the hard part is sticking to it. While you may not be able to control the rising cost of gas and groceries, you can control discretionary expenses, or things you want but may not need: like vacations, eating out, and streaming services.

If you’re struggling to limit your spending on nonessential things, try putting your savings money into a separate checking or savings account rather than just keeping it in with everything else. That way, you won’t be as tempted to let it all go on an impulse purchase.

4. Build a cash reserve

If you want to prepare for an economic downturn, building a cash reserve for emergencies should be your #1 priority. (The reason it’s #4 on our list is because it’s a lot easier to build an emergency cash reserve if you do those other three things first.)

Financial experts recommend having an emergency fund that will cover at least six to nine months, but if you’re struggling to get that fund up and running, you may want to shoot for something more attainable first, like three months. This is where understanding your financial situation and having an accurate budget come in handy: they’ll help you know exactly how much money you’d need for three months, and what you can cut back on to save those funds.

Rather than simply stashing that emergency cash in your sofa like your grandma may have done, consider putting it in an account that will grow but still allow you to access the funds in an emergency.

In addition to a cash reserve, we advise our clients on other emergency strategies such as:

● Life insurance
● Income protection insurance
● Trauma insurance
● Total and permanent disability insurance

5. Pay off high-interest debts

In a recession, high-interest debts are going to be one of the biggest drains on your finances, which is why it’s better to pay them off—or at least down—while you’re not strapped for cash.

But notice we didn’t say “pay off any and all debts at whatever cost.” Your highest priority should still be that emergency fund. After all, if you head into an economic downturn with all your debts paid but no money to fall back on for essential expenses, you’ll be forced to go back into debt just to cover your basic needs. Besides, some debts—such as student loans—may go into forbearance in the case of a recession anyway.

We recommend taking stock of your debts (something you hopefully did in step 1), and deciding which ones will be most worthwhile to focus on now. Remember, if you have to pay down debts at the expense of your emergency fund, it may not be worth it.

Conclusion

No one can fully prepare for a recession, but following these steps, and being consistent in good saving and spending habits, can go a long way toward making any financial emergencies that may come your way less of a crisis, and giving you the tools to handle them without fear.

Learn more about how we can help you manage cash flow and save for emergencies.