Odds are increasing for an economic downturn in the next year or two. Here’s what happens during a recession — and what you can do to be prepared.
Recession risks are on the rise.
Impending trade wars, accelerating layoffs, declining consumer confidence, and a stock market correction have Americans understandably skittish. According to Google Trends, searches on the term “recession” are at the third-highest level of the past 10 years.
These concerns are reflected in recent headlines. A sampling:
- “A Recession May Be Coming. It’s Not Too Late to Prepare” — USA Today
- “Consumer Confidence Drops Further, Key Measure Flags Recession Risk” — The Wall Street Journal
- “Recession Is Coming Before End of 2025, Generally ‘Pessimistic’ Corporate CFOs Say” — CNBC
- “Stocks Fall Sharply; Bonds, Gold Buoyed as Tariffs Stoke Recession Fears” — Reuters
To be sure, many aspects of the economy are humming along just fine. A recession over the next year or two is not a certainty. Goldman Sachs recently estimated the odds of a recession over the next 12 months at 35%.
But a recession eventually is guaranteed, because we haven’t yet figured out how to eliminate the boom-and-bust cycles of the economy.
The history of recessions
It’s commonly believed that a recession is defined as two consecutive quarters of declining GDP. While that’s definitely a sign of trouble, a recession has occurred only when the folks at the National Bureau of Economic Research say so. The NBER is a private, nonprofit research organization made up of more than 1,800 economists, and they officially designate when recessions begin and end.
Here’s one definition offered by the NBER: “A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real [i.e., inflation-adjusted] GDP, real income, employment, industrial production, and wholesale-retail sales.” As you can tell from the definition, the downturn has to be pervasive throughout the economy to be a recession.
The NBER provides data on recessions as far back as 1854. Since then, the U.S. has experienced 34 recessions — thus, on average, a recession approximately every five years. However, there was more than a decade between two of the last three recessions. And the last expansion, which is the term economists use to describe the time when the economy is growing in between recessions, lasted from 2008 to 2020 — which was the longest expansion on record. In fact, the 2010s was the only decade in which a recession didn’t occur.
The average recession has lasted 17 months; since 1945, the average has been just 10 months. The last two downturns were on opposite ends of the duration spectrum. The 2007–2009 recession lasted 18 months, the longest economic contraction since the Great Depression. But the recession caused by the Pandemic Panic of February 2020 was just two months — the shortest recession ever.
What goes up or down during a recession?
Recessions can have an impact on most aspects of your finances — and not all in bad ways. Here’s generally what rises and falls during a recession.
Stocks: Down
The stock market is considered a leading economic indicator, so it tends to drop several months before the recession officially begins. Also, stocks usually (but not always) rebound before the recession ends. Investors who try to time the market by waiting on the sidelines until the economy recovers often miss some of the best-performing days. According to Truist Co-Chief Investment Officer Keith Lerner, the median recession-associated decline in the S&P 500 (^GSPC -0.17%) since 1948 was 24%.
Source: YCharts.
Interest rates: Down … usually
The bond market and the Federal Reserve both react to recessions by driving down interest rates. However, if inflation stays high or increases during the economic downturn (what is known as stagflation), interest rates may actually go up, as happened during the 1973-1974 recession.
Source: YCharts.
Bonds: Up … depending on the bonds
Bond prices move inversely to interest rates, so if rates go down, bonds usually go up. Plus there’s often a flight to safety during a recession, which means people sell stocks and buy bonds, which drives up bond prices.
But it does depend on the quality of the bonds. Treasuries hold up well. However, investment-grade corporate bonds, historically, have been a mixed bag. Riskier corporates, such as high-yield junk bonds, go down along with stocks during a recession, though usually not quite as much.
For money you want to hold up during a downturn, stick with FDIC-insured cash and Treasuries, with perhaps a complement of diversified bond funds that are a mix of government-issued debt and investment-grade corporates.
Source: YCharts.
Home prices: Up … usually
Home prices declined in just two of the six recessions since 1980, and one of those was a decline of less than 1%. Research from Mark Hulbert of MarketWatch found that from 1952 to 2018, home prices, on average, actually rose more during bear markets in stocks than during bull markets.
Most of us remember the 2007-2009 recession, when both stocks and home prices plummeted. But historically speaking, that was an outlier.
Source: YCharts.
Unemployment rate: Up
On average, the unemployment rate rises by approximately 3 percentage points during a recession. But during the 2007-2009 recession, it doubled from 5% to 10%, and people were out of work for almost half a year. And during the pandemic, unemployment skyrocketed from 3.5% to 14.8%.
Source: YCharts.
Workplace benefits: Down or at least flat
Workers who are fortunate enough to keep their jobs could still experience a reduction in their overall compensation packages during a recession. Raises and bonuses are harder to come by, and companies that are really struggling reduce other benefits. For example, around 10% of companies reduced or eliminated the 401(k) match during the pandemic, and that figure was closer to 20% of companies during the 2007-2009 recession.
Inflation: Down … we hope
If there’s an upside to a downtrodden economy, it’s that the cost of living doesn’t go up as much — and usually goes down. Thus, if you have the means, a recession actually could be a good time to make a big-ticket purchase, such as a car or household appliance.
That said, many of us are old enough to remember the 1970s and the era of stagflation, when prices rose despite a muddling economy.
Source: YCharts.
Shore up your personal finances
To get your finances recession ready, start with the boring yet important Foolish advice to make sure you protect any money you need in the next few years by keeping it mostly in cash or short-term bonds. This is also a good time to examine your budget and reduce unnecessary or underappreciated expenses.
What you should do also depends on where you are along the road to retirement. If you’re several years or more from retiring, the No. 1 risk of a recession is job loss. So now is the time to bolster your human capital by:
- Looking for ways to demonstrate value to your employer and customers
- Keeping an eye on how your company is doing so you can anticipate layoffs
- Maintaining a professional network
- Keeping your skills up to date in case you need to hit the job market
- Making sure you have an emergency fund to pay the bills if you lose your job
If you’re near or in retirement, the concern is more for your portfolio, since you’ll soon be using it as a paycheck, if you’re not already. This is where asset allocation and diversification become very important. It starts with building an “income cushion,” which is five years’ worth of portfolio-provided income in cash or short-term bonds.
It’s also crucial to have a mix of different types of stocks and own enough of them — at least 25 (preferably more), with some index funds thrown in. You can invest in growth-oriented tech stocks but also have some solid dividend-paying consumer staples stocks. You don’t want too much of your portfolio relying on just one sector, industry, or style of investing.
Also, one of the best things retirees can do for the longevity of their portfolios is to not sell stocks when they’re down. Thus, retirees may have to cut back on spending during a recession or market decline.
There’s always a morning after
Economic expansions and boom times are sort of like the holiday season. We all spend more, we eat more, we go to parties, and we travel to see relatives. Our credit card balances go up — and we don’t think quite as much about our budgets.
Then comes the Jan. 1 hangover — i.e., a recession. The party is over, and it’s time to revisit the budget, pay off that debt, and make some resolutions about how we could be better with our money and our jobs. It’s also a good time to take a look at our portfolios, reassess our asset allocations, and perhaps do some rebalancing. Essentially, it’s a time to hunker down for the winter…and look forward to spring.
After all, an expansion and bull market follow every recession as reliably as the change of seasons. Economic winter might be coming … or not. But if so, it never lasts forever. And in the meantime, with every contribution to your 401(k) and IRA, you’re able to invest in companies at cheaper prices.
I’ll leave you with a parting thought from the Stoic philosopher Seneca: “The man who has anticipated the coming of troubles takes away their power when they arrive.”