In times of economic uncertainty, people worry about their financial stability — and sometimes make drastic decisions out of fear or uncertainty.
Why It Matters: Talks of a recession have been constant over the last year. Federal Reserve officials are signaling a sharp economic slowdown in the coming months. While this doesn’t guarantee a recession — though some experts are even talking about a potential “growth recession” — it’s a good time to consider how a downturn might affect your finances.
A recession is a period of economic decline, marked by a contraction in GDP for at least two consecutive quarters. During a recession, businesses and consumers tend to spend less, leading to reduced demand and lower prices. This can lead to job losses, reduced wages, and a decline in the overall economy.
Let’s explore the ways in which a recession can impact your savings — and what you can do to mitigate the effects.
How does a recession affect my savings?
Lower interest rates
During a recession, the Federal Reserve tends to lower its benchmark interest rates to stimulate borrowing and spending. Bank, in turn, follow suit, lowering rates on both loans and savings. While this can be beneficial for borrowers by making loans or mortgages less expensive, it can be detrimental to savers by lowering their returns. If you have a fixed-rate savings account, the interest rate will not change, but if you have a variable-rate account, your interest rate will likely decrease.
Stock market volatility
The stock market can be volatile during a recession. If you have investments in stocks or mutual funds, your savings can be negatively impacted by this volatility. The value of your investments can decrease significantly, leading to a loss of savings.
Job loss is common during recessions. Businesses may need to cut costs. If you lose your job during a recession, you may need to dip into your savings to cover your expenses until you find a new job. This can deplete your savings and leave you in a more precarious financial situation.
In addition to job losses, a recession can also lead to reduced wages. Businesses may need to cut employee salaries to stay afloat during tough economic times. If your wages are reduced, you may need to reduce your savings contributions or dip into your savings to cover your expenses.
How can I mitigate the effects of a recession on my savings?
Keep an emergency fund
An emergency fund is always important, yet it’s especially pertinent for times like recessions. This is a fund you set aside for unexpected expenses, such as job loss or medical bills. Experts recommend having three to six months' worth of living expenses in your emergency fund. If you don't have an emergency fund, consider building one.
Diversify your investments
To mitigate the effects of stock market volatility, it's a good idea to diversify your investments. This means spreading your investments across different asset classes, such as stocks, bonds, and real estate. By diversifying your investments, you reduce your exposure to any one asset class and increase your chances of making money over the long term.
Consider a high-yield savings account
If you're concerned about lower interest rates during a recession, consider opening a high-yield savings account. These accounts offer higher interest rates than traditional savings accounts, which can help you earn more on your savings. However, keep in mind that high-yield savings accounts may have higher minimum balances or other requirements.
Cut unnecessary expenses
Cut unnecessary expenses wherever possible. This can help you reduce your expenses and free up more money for savings. Look for areas where you can cut back, such as eating out, entertainment, or subscriptions.
Increase your savings contributions
If you're able to, consider increasing your savings contributions during a recession. To get started, take a close look at your current budget and identify areas where you can cut back or save more. You may also want to consider automating your savings contributions so that a portion of your income is automatically transferred into your savings account each month.