Confused about recessions? Read this 3 minute guide

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Everything you need to know about recessions in just a few minutes.

Key points

  • A recession is a prolonged period of economic decline.
  • Recessions often lead to layoffs and job insecurity.
  • Any steps you can take to shore up your emergency fund and pay off debt could help you weather an economic downturn.

Business leaders and economists have been ringing the warning bell about an economic downturn for several months. So what’s the problem? What exactly is a recession? And how can you prepare? Find out with our three-minute guide.

What is a recession?

The most common way to define a recession is as a prolonged period of economic decline. Recessions can be painful, but they are a normal part of business cycles. In good times, the economy grows. But in bad times, the economy contracts.

Some say that if the economy contracts for two consecutive quarters, the country is officially in recession. The reality is a bit more complicated. There is an organization called the National Bureau of Economic Research (NBER) that defines when a recession begins and ends, and uses a few different indicators to make that decision.

How long do recessions usually last?

Recessions can take different forms depending on what caused them and how they are managed. Looking at recessions since 1854, the NBER puts the average length at around 17 months. The shortest recession on record was the 2020 COVID-19 recession, which lasted just two months.

How could a recession affect me?

One of the biggest impacts of a recession is that people can lose their jobs. When faced with a decline in demand, companies look to cut costs. One way to do this is to first cut plans for new hires and then lay off existing employees. Economic downturns can lead to increased unemployment and reduced job security in general.

Another impact is that the value of your investments may fall. We already saw a bear market in 2022, and some experts are predicting that stock market performance could worsen in 2023. There is a lot of uncertainty about what could happen. But this kind of volatility can have a big impact on people nearing retirement age looking to withdraw from their portfolios.

What can I do to prepare?

The first step you can take to prepare for a recession is to understand your financial situation. Look at how much cash you have in your bank account, what your monthly expenses are, and how much money you owe. If you’re not sure where to start in terms of tracking your spending, a budget app might help.

Once you know where you stand financially, turn your attention to your emergency fund. Having three to six months’ worth of living expenses tucked away in a savings account can make a world of difference in the event of a financial emergency, such as the loss of a job.

If you have high-interest debt, particularly the credit card variety, look for ways to pay it off. If you lose your job or your income goes down, any debt payments will affect your monthly costs. Also, if you fall behind on your payments, you may have to pay late fees, your credit score could suffer, and you may eventually have to deal with debt collectors. The more you can afford before an economic downturn, the better.

Bottom line

Recessions aren’t fun, but they do pass eventually. We don’t know if we will enter a recession in 2023, and if we do, how bad the recession could be. The best way to prepare is to strengthen your financial foundation. If we hit a recession, you’ll be better able to weather the storm. If we don’t, you’ll be well positioned to handle any other financial emergencies that arise.

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