5 Ways to Protect Your Finances in a Recession

Keeping close tabs on your budget is a cornerstone of good financial health, especially when inflation is high.

When anticipating a recession, priorities are key. Begin by reviewing your budget and differentiate essential expenses, such as housing, food, transportation, and debt payments, from discretionary spending. Then, identify whether there are opportunities to curtail or delay your discretionary spending. How significant would the impact on your quality of life be? Sometimes delaying or downsizing big expenditures, like a new car or vacation abroad, won’t feel frightful and can significantly improve your near-term savings.  

Morgan Stanley’s Spending and Budgeting Tool can help you monitor incoming and outgoing cash, gain insights on your spending habits and create custom budgets no matter where your money is held—both at Morgan Stanley and externally.

Although the U.S. personal savings rate has declined sharply from its pandemic peak, ² maintaining a healthy emergency fund should remain a top financial priority. Doing so may help you stay afloat in unforeseen personal circumstances, such as a job loss or a family medical emergency.

At a minimum, aim to have three months’ worth of household expenses held in a checking or savings account. If you’re the sole earner in your household or you work in an industry that’s experiencing layoffs, make sure you’re stashing away at least six months’ worth of expenses. If you’re retired, having up to a year’s worth of expenses in highly liquid assets like cash can help you avoid having to sell longer-term investments when markets are down, which can lock in losses and reduce your future income.

If you’re creating a rainy-day account from scratch or rebuilding your emergency savings, start with small weekly or monthly contributions. If you receive additional income, such as a tax refund, bonus, raise or other windfall, consider putting a portion of that into your emergency fund. 

Interest rates have been trending upward recently as the Federal Reserve has been tightening monetary policy to rein in high inflation. Those higher rates may be bad news for borrowers, particularly anyone with revolving debts, such as credit cards.

If you have multiple debt balances, consider a debt consolidation strategy: You can take out a single, fixed-rate loan and use the proceeds to pay off various other, higher-interest balances. This can have the dual benefit of helping streamline your payments and potentially reducing interest costs.

Selling may feel tempting during times of market turbulence. After all, it can be hard to stand by while your portfolio loses value and not know when it might rebound. But a panicky decision to cash out is often a mistake: Selling into a falling market is more likely to lock-in realized losses than prevent new ones—and if you wait years to get back in, the damage to your portfolio can be extreme.

Investors who decide to sell assets and wait out the volatility will likely find it very challenging to accurately predict the right time to re-enter the market. Some of the stock market’s best days in history have come on the heels of its worst days, with little, if any, advance signal to investors.

Instead, staying invested through the market’s highs and the lows is often the right strategy for investors, as market history shows rebounds can return many portfolios to the black in just a few years. Volatility may be the price investors must pay to build wealth, but there are ways to help mitigate the disruption to your portfolio through time-tested strategies like rebalancing and diversification.

In difficult economic times, a financial plan can help you weather the storm and keep you focused on your goals. When constructing a financial plan, it is generally a good idea to build in “what if” scenarios, to take a peak around the corner, and give you some sense of the implications of a market move for your finances, so that you can react more calmly if things do eventually take that turn. Often, the best moves to make amid uncertainty are small and calculated. But if you lack a financial plan, identifying the best course of action can be challenging.