According to the National Bureau of Economic Research, the United States entered the Great Recession in December 2007. While economists might define a recession as a reduction in a country's gross national product, individual families might be faced with extreme financial hardships, including the loss of a job. In this article, we're going to provide some tips that can help families survive a recession. As part of that explanation, we're first going to describe what to expect during an economic downturn. By first gaining this knowledge, it will be easier to understand how to create a plan that helps ease a financial burden.
Economic Recessions
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According to macroeconomic theory, a recession is defined as the contraction, or shrinking, of a country's gross domestic product, which is the value of all the goods and services produced by a country each year. A less formal definition for a recession, and one that's used by the National Bureau of Economic Research, is a decline in economic activity lasting for more than a few months. During a recession, consumers can expect to see a reduction in corporate profits, an increase in unemployment, and a decline in investment activities.
Unemployment Rates
As the economy contracts, consumers begin spending less money on goods and services. As corporate revenues begin to decrease, there is downward pressure on corporate earnings. In an effort to increase profitability, companies begin to cut expenses, including their labor costs. This means there is a direct correlation between recessions and a decrease in wages, whether this is through the loss of a job or a reduction in overtime. Information obtained from the Bureau of Labor Statistics, provides a good illustration of the effect recent recessions had on unemployment rates:
Timeframe | Peak Unemployment Rate |
2007 - 2009 | 10.0% (October 2009) |
2001 – 2003 | 6.3% (June 2003) |
1990 – 1991 | 7.8% (June 1992) |
1980 – 1982 | 10.8% (December 1982) |
Even more alarming for some individuals is the long-term unemployment rate. Long-term is defined as persons unemployed for 27 weeks or more. Below is an interesting fact from the recession of 1980 - 1982: In June 1983, seven months after the official end of the 1981 - 82 recession, the long-term jobless rate peaked at 3.1 percent, the highest recorded in the post-World War II era. Studies have also shown that during recessions, employers will reduce the amount of overtime offered to workers. Once again, information from the Bureau of Labor Statistics tell us that during the 1980 - 1982 recession, manufacturers of durable goods reduced overtime hours by 84.2%.
Preparing for Recessions
The challenge of surviving typically involves both understanding what to expect, as well as being prepared for the worst. The loss of a job lowers household income, but a recession is usually accompanied by a drop in the price of stocks too. This means an economic slump will not only lower income, but also the value of investments.
An individual that loses their job will need another source of income to pay their monthly bills. Investors know that selling stocks at the tail end of a bear market is a losing proposition. (Remember, economic downturns and bear markets often coincide.) So the worst-case scenario for anyone hit hard by a recession is this:
They've lost their job
They're selling their stocks at bargain (low) prices
That's why the word recession is synonymous with terms like "cash crunch."
Here are some tips on how to prepare for a recession:
Start Saving Money
This first tip is the most important piece of advice that can be offered: start saving money now. Follow the philosophy of "paying yourself first," or there will never be enough cash to make it through a recession without going further into debt. When figuring out how much cash is needed, the rule of thumb would be to have enough money saved to pay for at least six months of expenses. Individuals that have created a budget before should understand how much money is required to pay their monthly bills. Throughout this website there are articles on building a budget, as well as online calculators. These tools can help individuals to better understand how much money they spend each month.
Refinance a Mortgage
In an effort to stimulate the economy, the Federal Reserve will often reduce interest rates. By doing so, the federal government hopes that by making money less expensive to borrow, companies will begin to expand their operations once again through long-term capital investments. That's good news for companies when they're struggling, and that's good news for individuals too. The coincidence of lower interest rates and the ability to extend the timeframe over which a mortgage is paid off is a tempting combination. Anyone that's struggling to make ends meet, or would like to save more money each month, might want to consider refinancing their existing mortgage. This doesn't mean a recession is a good opportunity to increase the home's debt load. The idea is to reconstruct an existing mortgage, and spread out the new payments over a longer timeline. There are plenty of mortgage calculators on this website that can provide insights into how much money can be saved each month by refinancing. The idea is to use the money saved each month to start building a "recession" fund.
Borrowing against Retirement
Finally, it's never a good idea to borrow money from a 401(k) plan, to pay for expenses today. However, if the decision is between losing a home and borrowing money from a retirement fund, the choice is clear. Each plan may have slightly different rules, but the IRS allows for 401(k) hardship withdrawals under certain conditions, including:
Money used to pay certain medical expenses for the accountholder, their spouse, or any dependents.
Payments of specific post-secondary education expense for the next year for the accountholder, their spouse, or any dependents.
The purchase of a primary residence.
Money needed to prevent eviction or foreclosure on a primary residence.
Hardship withdrawals made under a safe harbor provision may exclude a participant from contributing to their 401(k) plan for six months or more. Federal income tax on the hardship withdrawal may apply as well as a 10% penalty. Always check with a qualified tax consultant whenever withdrawing money from a retirement plan before age 59 1/2.
About the Author - Surviving a Recession
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