How a Recession Could Impact Your Life and Finances

Key Takeaways

Will there be a recession in the coming months? That seems to be the question on everyone’s minds, but there’s not a clear answer—yet. Many people hope that the Federal Reserve’s (Fed’s) break from interest rate hikes in June may help the economy avoid the hard landing of a recession.

However, Rich Weiss, American Century Investments Chief Investment Officer (CIO), cautions that the lag effects of higher interest rates are just starting to take hold in the economy, and it’s too early to declare victory.

When a recession strikes, it can have profound effects on individuals’ lives and finances. But it doesn’t affect everyone the same way.

To understand what a recession might mean for you, it’s good to start by revisiting what a recession is, how long one typically lasts and how it can affect various parts of the economy. Then consider some strategies designed to help you survive, and maybe even thrive, during challenging economic times.

What Is a Recession and How Long Does One Last?

A recession is defined as a period of declining economic activity that lasts more than a few months, according to the National Bureau of Economic Research (NBER). To qualify as a recession, declines must be spread throughout the economy rather than affecting only an isolated sector, such as housing or manufacturing.

A committee of NBER economists makes the official determination about whether the economy is in a recession. The decision is based on several factors, such as payrolls, real income, consumer spending and industrial production.

While some recessions may be relatively short-lived, lasting only a few quarters, others can persist for several years.

Since 1948, the NBER has recorded 12 recessions, which lasted an average of 10 months. Fortunately, the periods of economic expansion between each recession lasted much longer than the recessions themselves.

What Are the Causes and Warning Signs of a Recession?

The U.S. economy experiences ups and downs on a regular basis. Economic activity expands until it reaches a peak, then expansion slows and sometimes bottoms out in a recession. This is part of the normal economic cycle.

The factors that result in a recession are more nuanced. It’s always difficult to predict a recession, but there are several telltale economic indicators that may point to downturns in the economy.

Recession Signs

• Decline in economic growth. Two consecutive quarters of negative growth in the gross domestic product is generally the NBER’s definition of recession, but it’s not a guarantee.

• Inverted bond yield curve. The yield curve is a graphic representation of bond yields at different maturities, and an inverted yield curve often precedes a recession. An inverted yield curve has longer-maturity bonds with lower yields than shorter-maturity bonds, which indicates that bond investors see the economy slowing.

• Increase in job loss, decrease in personal income. When the economy slows, employers look for ways to save money, which often results in reducing employees’ hours or laying off workers. As a result, income levels decrease, and people have less money to spend. Economists consider payroll levels across the economy when determining whether a recession is underway.

• Slowdown in consumer spending. When people are spending less money throughout the economy, either because many of them have lost income or because inflation has driven up the price of goods, that may be another sign of an economic downturn.

• Slower manufacturing activity. When consumers aren’t buying as many goods, there is less demand for manufacturers to keep up production. As a result, manufacturers often slow down production—another prediction of a potential recession.

What Does a Recession Mean for You?

There’s a long history of recessions in the U.S. Each one is unique and affects people’s lives and finances differently.

Investors: What Does a Recession Mean for Investment Strategies?

Market ups and downs occur daily, but recessions commonly bring deeper market declines. A bear market, which is a decline in value of more than 20% from the market’s previous high over an extended period, is often—but not always—accompanied by a recession.

When investing in bear markets, it’s tempting to sell some holdings rather than continue watching prices fall—but doing so may result in greater losses. Selling when the market is low locks in losses; you no longer have the opportunity for those holdings to rebound. Also, having fewer stocks in your portfolio leaves you with reduced ability to potentially recoup some losses when the market bounces back.

Over the past 50 years, stock prices have typically fallen during the early part of a recession, but the opposite has occurred during the second half of a recession, with stocks showing strong positive returns. Investors with diverse portfolios may be able to weather recessions, and those with money to invest can add to their portfolios with bargain prices.

Workers and Business Owners: What Does a Recession Mean for Jobs?

During a recession, unemployment typically rises as some employers try to cut payroll costs to stay afloat. Some industries are more susceptible to cuts than others. For example, many tech companies have announced layoffs over the past year. Other industries that are typically at risk during recessions include construction, personal services and tourism because consumers have less discretionary spending available.

While some businesses struggle during a recession, others may thrive. For example, grocery stores and food manufacturers often stay busy, as consumers dine out less often to save money. Similarly, cheaper entertainment providers, such as streaming services, may boost revenue. And because people are more likely to repair old cars than buy new ones during a recession, car maintenance shops may also maintain a brisk business.

Home Buyers and Sellers: What Does a Recession Mean for Housing and Mortgages?

During a recession, people usually spend less money than normal because they’ve lost income or they’re worried about their finances. As a result, demand for homes decreases, construction of new homes slows and home prices often drop—although that can depend on location.

In addition to lower home prices, mortgage interest rates might decrease during a recession as fewer people borrow to buy homes. Currently, however, the Fed continues to forecast two more rate increases during 2023, which will continue to keep interest rates rising.

Even if interest rates drop, a recession is a time of economic uncertainty and, for many people, job loss or instability, so whether it’s a good time to buy a home depends on a person’s individual financial situation.

Borrowers: What Does a Recession Mean for Other Loans?

During a recession, banks and other lenders usually become more cautious about risk and tighten their lending standards. At that point, fewer people qualify for loans and credit, so interest rates gradually drop.

People who qualify for new credit during a recession may be able to secure it at a lower rate. However, economic uncertainty and the ongoing risk of layoffs make a recession an uncertain time to borrow money.

How to Survive (and Maybe Even Thrive) During a Recession

Being prepared can help you be ready for when a recession hits. Start by taking some smart financial steps, such as:

• Building your emergency fund, aiming for enough to cover at least three months’ worth of expenses.

• Cutting back on spending as much as possible.

• Paying down high-interest debt as quickly as you can.

• Seeking out additional income streams, such as a side job or part-time gig.

When you’re living through a recession, you can continue to make smart financial choices to help you ride out the challenges and land on firm footing on the other side. Some of the best financial choices to make during a recession include:

• Prepare your resume and nurture your network. Despite your best efforts, layoffs during a recession happen—so it’s a good idea to revamp your resume and have it ready.
  
  Make sure your professional online profiles are up to date and use them to interact with your network on a regular basis. Focus on providing help to others in your network by making introductions and offering helpful advice. If you end up needing to find another job, your network will be primed and ready to help.

• Revise your budget and stick to it. Sticking to a budget is important for managing money wisely anytime, but during a recession, it’s crucial.
  
  Even if you already have a budget, take time to revisit it and look for areas to cut back on spending. Budgeting during a recession is a little different because you may have less money available to cover your needs or you may need to focus on setting aside more savings in case of a potential layoff.

• Take advantage of financial assistance if needed. If you’re short on cash and your mortgage lender or student loan provider is willing to pause payments, take advantage of the temporary reprieve.
  
  Some credit card companies or lenders may be willing to adjust their terms to make it easier for you to stay on track with your payments. If you need help, don’t be afraid to contact your creditors to ask.

If you’re unsure about your financial footing heading into a possible recession, talk to a financial professional who can help you navigate the uncertainty.