How to recession-proof your finances

The Bank of England has warned that the UK is facing a prolonged recession, while analysts predict that Britain’s economy will suffer the biggest hit of any other G7 country next year.

Prices are rising at the fastest rate in 40 years, eating into people’s budgets and outpacing growth in pay. This is causing the economy to shrink, with the latest figures showing it contracted by 0.6% in September.

While you can’t stop a recession from happening, there are things you can do to protect yourself financially.

What is a recession?

A recession is defined as the economy shrinking over two consecutive quarters, or six months.

When the UK economy contracts, it’s usually a sign that consumers are spending less. This has a knock-on effect on businesses, which produce less in the way of goods and services.

A recession can affect our earnings and employment.

The size of an economy is measured by something called GDP.

What is GDP?

GDP stands for gross domestic product. It measures the size of the economy. So when GDP goes up, this can sometimes be a sign that businesses are thriving and the economy is growing.

The Office for National Statistics gathers data from thousands of companies around the UK to come up with a figure for GDP. 

Confusingly, there are three ways of measuring the economy:

• The total value of goods and services produced
• Everyone’s income that is generated by the production of goods and services 
• All the money spent on goods and services (minus the value of imports, plus exports)

These are known as the output, income and expenditure measures of GDP. 

In theory, all of these three different measures should give the same figure.

Is the UK going into a recession?

The economy shrank by 0.6% in September, according to the latest official figures.

When the economy shrinks, it’s a sign that we could be heading into recession territory.

Between July and September it shrank by 0.2%, according to the ONS. This aligns with predictions from the National Institute of Economic and Social Research (NIESR ).

The Bank of England said that the UK is facing a two-year recession and expects the economy to shrink by 3%. Unemployment is forecast to hit 6.5% from 3.5%.

But GDP figures have been up and down this year:

March	April	May	June	July	August	Sept
GDP	-0.1%	-0.3%	+0.5%	-0.6%	+0.2%	-0.3%	-0.6%

The Bank of England has predicted that the economy will shrink at the end of this year and continue doing so until the end of 2023. On 3 November it said that GDP is expected to decline by 0.75 percentage points in the final six months of 2022.

According to the National Institute of Economic and Social Research (NIESR ), the cost of living crunch could cause the UK to enter a recession in the second half of this year.

The NIESR predicted that GDP will fall by:

• 0.2% between July and September (this prediction has come true according to the latest figures)
• 0.4% between October and December

Meanwhile, the multi-governmental Organisation for Economic Co-operation and Development (OECD) expects the economy to grow by 3.6% in 2022. It is then expected to shrink by 0.4% in 2023 before growing by just 0.2% in 2024.

If these figures come to fruition, this will mean the UK is the slowest growing nation of the G7 group of advanced economies, which also include the US, Canada, Germany, France, Italy and Japan.

While most G7 countries are expected to see shallow growth in 2023, UK and German economies are set to shrink.

The Office for Budget Responsibility (OBR) expects the UK economy to shrink by 1.4% in 2023, followed by growth of 1.3% in 2024.

What could cause the UK to go into a recession? 

The cost of living is increasing, forcing people to spend more money on household bills and leaving them with less disposable income (or none at all).

The costs of gas and electricity are the biggest factor. On top of that, people are facing higher food, fuel and borrowing costs.

The situation is getting worse as the year goes on, with inflation currently at 11.1%. As a result, people are reining in their spending on products and services, including essential items. 

As purse-strings are tightened, less money is flowing into businesses. Consumer spending accounts for two-thirds of GDP in the UK, so when this falls, the economy shrinks.

The last time we were in a recession was in 2020 as the UK economy reeled from the impact of the Covid lockdowns. It shrank by 10% over the year, which marked the UK’s worst economic performance in 300 years.

But the effects of the recession following the financial crash of 2008 had a more long-term impact: it took five years for the UK economy to get back to the size it was before the recession.

What are the warning signs of a recession?

There are a number of red flags that a recession could be on its way.

We outline five of them below.

1. Stock market wobbles

The stock market can be reactive to economic factors. For example, when GDP figures showed a 0.3% decline in the economy in April, the market plunged.

Downturns in share prices can reflect a loss of investor confidence in the future earnings potential of the companies where they have placed their money. They see people spending less on the products or services produced by those companies and look to sell their shares.

This kind of market judgment can be a sign that we are heading towards a recession. It can also be a self-fulfilling prophecy in that plunging share prices have a further damaging impact on the confidence of consumers and investors alike.

If there is widespread selling of stocks it could also be a sign that people are feeling the pinch and they might want to cash in their investment profits to give themselves extra income.

2. Increase in the unemployment rate 

From July to September this year, the UK unemployment rate was 3.6%, according to the Office for National Statistics. In this period, the number of people in employment fell by 52,000.

Compare this to the end of the 2009 recession when the unemployment rate reached 9.5%, before peaking at 10% in the following months. We are a long way from that.

However, it’s one to keep an eye on because higher unemployment could be a sign that businesses are struggling, causing people to lose their jobs.

The Bank of England predicts that the unemployment rate could almost double to 6.5% in 2023 as the UK heads into a recession.

3. Job vacancies fall

You might notice the number of job vacancies fall as businesses stop hiring. When there’s so much uncertainty about the future, companies lose confidence and expansion comes to a halt.

In the three months to August the number of job vacancies reached 1.26 million, a fall of 34,000 from the previous three months.

But despite the fall, it doesn’t look like there is much to worry about yet on this front.

The number of job vacancies in March to May 2022 had reached a record high of 1.3 million. That’s up 503,900 from the pre-pandemic level in January to March 2020.

4. Businesses report losses

Another possible warning sign of recession might be more companies reporting losses rather than profits, reflecting dwindling demand.

The first businesses to struggle might be those that sell goods and services deemed a luxury, such as those selling new cars.

While the health of a single company won’t tell the whole picture, if lots of businesses are losing money then it’s likely this will have a knock-on effect on employment and wages. This in turn would have a damaging effect on the economy.

5. Real wages fall

If average earnings fails to keep up with inflation then that means that the money we have in our pockets is falling in real terms.

The latest estimates suggest that between July and September, average regular pay (excluding bonuses) increased by 5.7%. Meanwhile, inflation was between 9.4% and 10.1% over that three-month period.

This means that workers are actually seeing their pay fall by more than 4%.

How would a recession affect me?

The problems caused by a recession can trickle down to our everyday lives and the impact can be felt for years, even once the economy starts to recover.

There are a number of ways it could affect your life:

• You might find it harder to get a promotion or a pay rise
• Or worse, you or people you know could lose their jobs as businesses try to save money
• It could be harder to find a new job as vacancies disappear
• If you run a business, you might have to let go of colleagues as you scale down your workforce
• Your company could collapse 
• You could be made bankrupt
• Shops you once visited might close down

A recession won’t affect everyone equally. In fact, an economic downturn can create more inequality in society, widening the gap between the rich and the poor.

People who have savings and a more secure (or diversified) income will be better off than those who don’t.

We have assembled some tips below to help you cope with a recession.

Seven ways to recession-proof your finances

Many of the ways to recession-proof your personal finances involve simple strategies:

1. Living within your means

Having debt isn’t a problem when times are good and you can afford to meet your repayments every month.

But when we are in a recession, this increases the risk of redundancies. If you lost your job, could you afford to pay the debt off? 

We don’t know what the future holds, but if you have expensive debt on credit cards and loans, look to pay this off quickly if possible. 

You might want to consider consolidating all your different card debts onto one of these credit cards, which have an interest-free window of up to 34 months.

If you can avoid it, don’t take on any new debt — and make sure you aren’t spending more than you can afford each month.

If you are heavily reliant on debt to make it through every month, our article gives you guidance on how to get help. 

2. Reduce your outgoings

The cost of living crisis is forcing many families to tighten their belts.

If you haven’t yet taken a cold, hard look at your finances, now is a good time to do so.

Even small outlays such as a £3 coffee can add up to a lot if you spend this on a regular basis. It might be helpful to add all the costs up and work out how much you could save every month, or even over a year.

You can cut down on your food bill using these tips. 

Writing down your income and all of your outgoings can put things in perspective too. You might want to make use of these top budgeting apps too.

We’re not saying you should deprive yourself of every luxury and never enjoy life, but it’s a good time to think about where your money is going. 

Reducing your outgoings will help you save to give yourself a financial buffer during a recession, which leads us onto the next tip.

3. Save an emergency fund

If you were to lose your job and struggle to make ends meet, would you have any savings to fall back on?

It’s always good to have an emergency fund equal to between three and six months’ earnings, which should be kept in a top easy-access savings account so you can dip into it whenever you need.

If times get tough, this emergency fund could give you a financial cushion.

Here are 20 simple ways to save money.

4. Earn extra income  

If you are worried about how secure your job would be during a recession, perhaps it’s time to think of ways you could try to earn extra money. 

Having multiple sources of earnings could protect you if one dries up, so you might want to diversify. See 13 ways to boost your income.

When recession strikes, it’s important not to take your job for granted. If you decide to head for the door when other businesses aren’t hiring, you could struggle to find a new position.

However, at the moment job vacancies are at a record high, so if you are keen to change jobs, you might want to do this sooner rather than later.

5. Invest for the long term

If you have followed the savings tips above and still have some disposable income, you could consider investing. 

Contrary to what you might think, putting money into assets such as shares during a recession could be a good idea. It might mean you can buy some bargains among the companies whose share prices have fallen amid the stock market turbulence. 

But it is important to do some research on businesses that seem fundamentally sound and are likely to bounce back when the clouds lift. You should also remain invested for at least five years, even when the markets get spooked by turmoil, to give yourself time to ride out the downturns and enjoy the recovery. 

For example, if you had invested £10,000 in the FTSE All-Share index in May 1989 and kept it invested until April 2022, it would have grown to £140,287. That’s despite years of economic turmoil during those three decades.

It’s also never sensible to put all your eggs in one basket by sticking to a small handful of companies or market sectors. This is especially true during a recession. If you invest in a couple of companies and they both collapse, you could suffer severe losses. 

We go into detail about the principles of investing in our beginner’s guide. You also might want to read our article on how to invest during a recession.

6. Protect your retirement

It might be tough right now but you should resist the temptation to cut your pension contributions.

If you have cut back already then start topping up your pension again as soon as you can.

A 25-year-old who reduces their pension payments by just 2% could miss out on £60,000 across their lifetime, according to wealth manager True Potential. If you’re not sure how a pension works, read our guide.

There might be other areas of your monthly spending you can look to cut first.

7. Avoid making impulsive decisions

Making impulsive decisions about your finances is not recommended at any time – but a recession is the worst time of all.

Splurging on big-ticket items might seem fun at the moment, but you might regret it later on if your income ends up being stretched to the limit.

Now is the time to think logically about your finances and avoid taking big risks. 

You might want to delay big financial decisions for now. Focus on putting yourself in a good position instead, to give you room for manoeuvre when times get tough.

SOURCE https://www.thetimes.co.uk/money-mentor/article/recession-proof-finances/