Red-hot inflation has been the story of 2022, and the BoC is stuck between a rock and a hard place - trying to control inflation by raising interest rates, which then runs the high risk of an economic downturn.
Although there may be a chance that we don’t enter into a recession and the BoC is still hoping for a soft landing, it’s best to be prepared.
WHAT IS A RECESSION?
When many people think of a recession, they may recall the global financial crisis that occurred in 2008, and the ensuing chaos. Recessions aren’t always this dramatic, though, and can vary in severity.
There are many different definitions of what a recession is, but a simple one is given by the National Bureau of Economic Research (NBER):
A recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months. It can affect several aspects of the economy, such as real GDP, income, industrial production, employment, retail sales, and industrial production.
GDP is an important indicator of where the economy is potentially heading. Current statistics show that Canada’s GDP is very close to stalling and has moved very little recently (0% growth between April 2022 – May 2022).
HOW YOU CAN PREPARE FOR A RECESSION
Recessions aren’t just bad for businesses; they’re bad for everybody. During a recession, it’s common to see rising costs paired with job cuts, pay cuts, stock market drops, and reduced income security.
It’s a good idea to start preparing for a recession now so you aren’t caught off-guard. Here are some practical tips that you can employ to make sure you’re ready for the oncoming market downturn.
1. Evaluate your current investments
The main question you should be trying to figure out when looking at your investments is: “How much risk am I exposed to?” Depending on where your assets are held, try to get a total view of what you have and what your potential losses could be. You might need to look at your self-directed financial statements, contact your financial advisor, or evaluate your pension plan at work.
This will have a lot of variation among different people. For example, if you've invested in 100% Canadian equities, look at worst-case scenarios, such as during the 2008 financial crisis when the TSX Index dropped by 35%.
The next question you should ask yourself is, “Am I willing to accept this risk?” If the answer to that is no, then it means your risk tolerance potentially does not properly match your investments and that you might consider adjusting it. Some de-risking strategies are investing more in fixed income, cash, or equities in more stable sectors (such as utilities).
If you’re unsure what your current risk tolerance is, consider doing an investor questionnaire.
2. Reduce your monthly expenses
When a recession hits, the first thing businesses do is reduce their overhead costs. They may cut funding to departments, put pay raises on hold, and avoid unnecessary maintenance.
Consider doing the same at home.
First, sit down and look at your monthly budget. It helps to have a full view of all of your family’s expenses, including rent, mortgage, utilities, groceries, fuel, and leisure.
There’s a pretty good chance that you can find some areas where you can cut down on your expenses. Evaluate the big three expenses in your budget: Housing, transportation, and food. See if there’s any way to cut down on any of those areas.
During a recession, there’s a higher likelihood of losing your job. If you own a business, you may find that fewer clients renew their contracts or fewer shoppers buy your products. This can tighten your personal finances and make bills difficult to pay.
During these periods, it’s vital to have an emergency fund. Hopefully, you won’t have to use it. If the worst happens, at least you’ll have it there to help you make it through unscathed.
3. Build on your most valuable skills
During a recession, it’s important to keep providing value. If you’re an employee, try to hone your skills and become the best at what you do, so you’re the least likely to get let go if there are rounds of layoffs. If you run a small business, focus on being the best in your industry and offer exceptional service to your clients.
When money is tight, people and businesses will continue investing in people and products that bring them value.
FINAL THOUGHTS
There is no way to exactly predict how long a recession will last, but we can look at the history to give us a rough idea. Canada has experienced only five recessions since 1970, and they usually lasted between three to nine months. Unfortunately, there’s little that any of us can do to prevent a recession. By preparing ahead of time, we can limit a recession's ability to harm us financially.
If you’re smart with your money, increase your value, save where you can, and eliminate unnecessary spending, you’ll be able to survive and potentially even thrive through a recession.
Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.
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