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How to prepare your finances for a recession

Here's what to do with your debt, savings, investment portfolio, mortgage and your KiwiSaver before and during a recession.

A recession or any kind of market downturn can be a scary time as unemployment rises, incomes fall and bills continue to come in. However, there are things you can do to prepare. Doing a general tidy up of your finances now and having a plan in place can save you a lot of money, time and stress down the track.

Focus on paying down your debt

Having a plan in place to pay off your debt is always important, but it’s especially vital prior to and during a recession. There’s a higher chance of being made redundant or having your hours cut back at that time, which could make it really difficult to meet your repayments.

When starting to pay down your debt, you should prioritise some debts over others.

Credit card debt and personal loans

If you have credit card debt or a personal loan, it’s a good idea to focus on paying off these first. These products typically charge a higher interest rate than other credit products. While you might have this debt under control now, these could become difficult to pay down if you were to suddenly lose your income.

A balance transfer credit card allows you to transfer your debt over to a new card with a low or even 0% interest rate for a set period. Using a balance transfer credit card could save you money on interest and also help repay your debt quicker.

If you have several personal loans, you could consider combining these into one with a debt consolidation loan, which means you’re not paying multiple sets of loan management fees.

Student debt

Student debt is less urgent, as you’re not charged interest and it’s simply indexed each year for inflation. This debt starts to be paid from your salary automatically once you earn above the income threshold, and it’s taken from your pay before it even lands in your account (much like tax).

Because the inflation rate is so low right now, there’s no urgent reason to rush into paying this off. If you’ve got money to spare, it’s much more worthwhile to first pay off any high-interest debt you have. Once this is paid down, you should use any remaining money you have to start building up your emergency savings.

Build up your emergency savings

In times of economic uncertainty, it’s essential to have some cash savings at hand. It is especially essential if you’re a casual worker. If you’re made redundant, you could face unemployment until the economy picks back up, which means no money is coming in, but you still need to meet your regular bills and ongoing payments.

Also, in times of economic uncertainty, we usually see big falls in the value of stocks and other assets, so cash is a much safer and less risky option.

No one can predict how long a recession might last, so as a general rule, it’s a good idea to build up an emergency savings fund of three to six months’ worth of living expenses. The amount you should aim to have saved is different for everyone.

Here’s how to start building up your emergency savings.

Calculate how much you need to save

The first step is working out how much you need to have in your emergency savings, which means calculating three to six months’ worth of living expenses, which can sound daunting. A good way to tackle it is to look back on your transaction history over the last few months and make a note of all your living expenses.

Common examples of living expenses include the following:

  • Electricity, gas, Internet and phone bills
  • Mortgage repayments or rent
  • Health insurance payments, regular prescriptions and medication
  • Groceries
  • School fees, uniforms and supplies
  • Public transport costs, petrol and car registration

Bear in mind that living expenses mean the things you buy that are essential to your day-to-day life, so things that are in the “want” rather than “need” category aren’t included.

Examples of costs that usually aren’t living expenses include the following:

  • Eating out and takeaway foods
  • Gym memberships or personal training (unless for medical/rehab purposes)
  • Alcohol
  • Entertainment costs like Netflix, Spotify or movie tickets
  • Holidays and travel

Create a budget and reduce spending

Once you’ve worked out your average monthly living expenses, it’s time to put together a budget. Let’s say you’ve figured out you need $2,000 a month for living costs, and you want to save up an emergency fund of four months’ living costs. That’s $8,000 you need to have in your emergency savings. How are you going to save this?

As a starting point, you need to trim your spending. It’s likely that going through your past transactions has revealed some spending patterns you didn’t realise you had. Perhaps you discovered you were spending more money on eating out than you thought you were? Or, maybe you were surprised by how much money you spend each month on various streaming services? Work out where you’re currently overspending and start to cut down.

Following this, take a look at all your products and services to see which ones you no longer need and which ones you could get cheaper, which includes shopping around and comparing your health insurance, energy plans and mobile plan. It may take a couple of hours of work, but you could save hundreds of dollars by switching to better deals.

Increase your income, if you can

While you’re actively trying to reduce your spending, try to find ways to bring in more money if possible, which is especially important if you’ve already been following a budget and don’t have many opportunities to reduce your spending further.

Here are a few options to increase your income:

  • Ask for a raise. If you haven’t asked for a raise in a while, it could be a good chance to do this now. If you can pull together a solid case as to why you deserve an increase, you won’t lose anything by asking.
  • Do part-time work. You could try to pick up some weekend shifts in a cafe or bar near you or do some freelance work after hours. You could even drive for Uber, rent out a spare room or start a side hustle.
  • Sell things. Sell items you no longer use or need on TradeMe, Neighbourly or Facebook Marketplace for some extra cash.

Put your emergency savings in a safe place

Once you start building up your emergency savings, it’s important you have a safe place to put it that’s earning you a bit of interest. Here are a couple of options:

  • A high-interest savings account. Savings accounts pay a small amount of interest on your balance. As an incentive to save, they often offer bonus interest when you can deposit a certain amount each month. One benefit of a savings account is that you can access the money instantly if needed.
  • A term deposit. Term deposits are a type of locked savings account. The benefit of term deposits is they pay a fixed interest rate that won’t change for the life of the term. However, you can’t access your money instantly if needed.

Sort out your mortgage

If you already have a mortgage, then it’s a good idea to start thinking about paying it down faster. A mortgage is the biggest debt most people have and ends up costing the average borrower hundreds of thousands of dollars in interest over the life of the loan.

Minimising your home loan debt is a great way to recession-proof yourself, but there are a few things to think about:

Do you have other debts?

Mortgage debt (along with student debt) is typically less urgent than personal loan or credit card debt. You should prioritise the most expensive, high-interest debts first.

How high is your current home loan interest rate?

Refinancing to a lower interest rate can save you money without too much effort on your part. Check if your current rate is too high (rates have fallen well under 4% as of March 2020) and if so, apply for a new loan with a better rate. A home loan application can take hours of your time, but the potential savings make it worth considering.

Do you have an offset account?

If your home loan has an offset account, then you have a very flexible way of minimising your loan interest without losing the money you may need later if you’re affected by a recession.

An offset account functions like a bank account, but it’s attached to a mortgage and the money earns no interest. Instead, the money offsets your loan principal (the amount you owe your lender), which means your interest charges are reduced. You still repay the same amount every month or fortnight, but more of the money goes toward your principal and less on interest, which means you repay the loan faster and pay less interest in the end.

And because the money is still sitting in a bank account, you can pull it out and spend it later if you need to. It’s the ultimate rainy day fund: reduce your interest costs now and still have money to hand if you need it.

If your loan doesn’t have an offset account, it might be worth refinancing to one that does and then putting some savings into it. It’s a wise recession-proofing tactic.

If a recession hits, property gets cheaper, right?

Unfortunately, there’s no guarantee that a declining economy automatically means declining house prices. However, it’s certainly possible. No one truly knows what the future holds.

Other factors, especially credit availability (how easy it is to get a loan) can affect prices a lot more than negative growth in the broader economy.

The sad fact is, property prices are high in New Zealand and wages haven’t grown that much. Waiting for a recession to hit and then scooping up a property bargain is probably an unrealistic dream.

How to invest during a recession

In a recession or during an economic downturn, some investments are hit harder than others. It’s important to have a clear investment strategy in place so if a recession does occur, you have a well-thought-out plan so you avoid making last-minute, panic-driven decisions that could end up costing you.

Should you sell your shares?

Usually, stocks are among those hardest hit, so if you’ve got a large portfolio of shares, it can be tempting to sell. However, this isn’t always the best idea. When preparing your investments for a recession, ask yourself these questions:

  • Will you need the cash? If you think you may need the cash if a recession were to happen (for example if you think you’re likely to be made redundant and you don’t have an emergency savings buffer), you could consider selling some of your shares, even though you could be taking a loss. However, selling your shares when the price falls locks in that loss of capital, so it could be better to focus on building up your emergency savings first before you resort to selling any stocks.
  • Can you manage without the cash? If you don’t think you need the money any time soon, you could consider holding your investments and riding out the volatility. It could get worse before it gets better and it may take several years, but historically the stock market tends to go up over the long term.
  • Are you about to retire? If you’re close to retirement and you think a recession is on the cards, you won’t have as much time left to ride out the volatility and wait for the share market to recover like you would if you were in your 30s or 40s. In preparation, you could consider selling some of your positions before their price drops too much, and moving the money into a cash product instead. But remember, depending on your age, you could be in retirement for another 20 years or even longer. It’s highly likely your stocks are going to recover in this time and keeping some of your money invested in growth assets like shares helps your retirement savings last as long as possible.

Remember, like any global economic event, there are winners and losers in a recession and not all stocks will go down. So, whether you sell or not also depends on what you currently have in your portfolio.

Should you buy more shares?

During a recession, we usually see heavy falls in the stock market as investors sell their shares and move their money into low-risk cash products. However, some stocks won’t be hit as hard and some even rise in value. However, one thing is certain: a recession presents some good buying opportunities for those who are prepared to do so.

Some shares that could go up in a recession include the following:

  • Consumer staples. Companies like grocery stores might not be as greatly impacted as other sectors since consumers still need to buy day-to-day items.
  • Healthcare. If the recession is brought on by a pandemic, we are likely to see some healthcare, medical research and biotech stocks rising.
  • Gold companies. Gold is a safe-haven asset that investors flock to in times of economic uncertainty, so in the lead up to and during a recession, we usually see the price of gold jump up. Read our guide on gold investing for more details.
  • Hedged ETFs. Some ETFs track market volatility and actually rise as the market falls and fall as the market rises.

Tips to prepare your investment portfolio for a recession

Here are some tips to help you prepare and manage your investments before and during a recession.

  • Focus on diversification. As outlined above, while some investments fall in value, others outperform in a recession (and some remain relatively flat or stable). One of the best ways to protect your portfolio from volatility is by not having all your eggs in one basket. Instead of selling your shares, consider holding your shares and instead buy other assets that are likely to go up to minimise your overall losses.
  • Adopt a long-term mindset. Unless you’re an active day trader, keep a long-term mindset for your portfolio. Yes, the market falls from time to time, but it almost certainly picks back up again and rises over the long term. The short-term volatility might be uncomfortable, but by focusing less on the day-to-day price movements, you can keep a level head, remain calm and stick to your course.
  • Create a shopping list of stocks to buy. When the market is falling and the economy is slowing, it can seem counterintuitive to invest more money into the share market. However, during a recession, you find plenty of good-quality stocks trading for a significant discount, which presents some great buying opportunities. As part of your preparation for a recession, put some money aside and create a shopping list of what you want to buy so that, when the price is right, you can act quickly. If you don’t already have one, open an online share trading account so you’re ready to trade when there’s a good opportunity.
  • Stay informed, but ignore the hype. When the market is moving, whether that’s falling sharply or rising quickly, there’s going to be lots of hype. Everyone has an opinion on what to buy, what to sell and on when it’s the right time to buy. Remember, timing the market is a risky strategy that can be very costly, and at the end of the day, no one really knows for sure what the market is going to do next.

What about investing in property?

Collapsing stock prices and falling interest rates are making property look pretty attractive, right? There’s certainly something reassuring about investing in bricks and mortar. Property might not be the highest yielding investment, but it’s typically a long-term game and relatively stable. Property is less exposed to short-term economic contraction, pandemics or disasters (unless you buy in an area that’s disaster-prone).

The truth is that no investment is ever guaranteed. If you do decide that now’s the time to invest in property, make sure you consider the following:

  • Invest for the long term. It is possible to “flip” a property for a short-term gain, but not everyone can pull this off and it’s harder to do in a recession. Take your time, do your research and invest in the right property in the right location. Consider factors like demand, population growth, future infrastructure, proximity to shops and schools and overall desirability.
  • Buy in a “recession-proof” area. Investing in towns or regions dependent on a single industry is very unwise during a recession, which is also true for seasonal holiday destinations, for instance.
  • Find the right loan. New Zealand investors can use their investment costs to minimise their tax bills. Finding the right type of investment loan is a key part of this strategy. Plus, whatever strategy you go for, getting a lower interest rate on the loan saves you even more.
  • Don’t try and time the market. Every investor wants a good deal, but buy low and sell high is for stocks, not property. Buy quality and hold for the long term is the most common property strategy.

What to do with your KiwiSaver

It’s not often at the front of our minds like our cash, personal investments and property, but your KiwiSaver will be impacted in a recession too. Your KiwiSaver is a big investment portfolio that’s made up of a bunch of different assets, most notably shares. Importantly, your KiwiSaver could be one of the biggest assets you have by the time you retire.

To prepare for a period of economic downturn, the first thing to do is to make sure you’ve only got one fund (this is actually important all the time, not just in a recession). If you’ve got multiple funds, you pay multiple sets of fees which is unnecessary and eat a big hole into your retirement savings. If you find you have more than one fund, you should consolidate them.

If you already have just the one fund, the strategy you take with your KiwiSaver, while preparing for a recession, depends on your age, your risk tolerance and your personal circumstances.

Need more help?

Taking control of your finances is daunting at the best of times. When facing a recession, it’s even scarier. We hope that the information on this page helps you save money on your financial products and helps you make some good decisions.

If you need more guidance on saving money, managing debt or need the services of a counsellor, check out some of these links.

  • If you are in financial distress, please read our emergency finance help information or call WINZ on 0800 559 009.
  • MoneyTalks can put you in touch with a financial mentor.
  • Please know that whatever financial and emotional stress you’re suffering, you are not alone. Call Lifeline on 0800 LIFELINE (0800 543 354) if you need help.

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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