What Does a Recession Mean for Your Finances?
Here are some general tips for managing your finances during a looming recession.
For some advisors, two negative quarters of Gross Domestic Product means we are in a recession. Other advisors are waiting for the National Bureau of Economic Research (NBER) to officially declare one. NBER defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
The problem with waiting for the NBER to proclaim a recession is that by the time they do, it may be too late to improve your finances since there is typically several months of lag time before their announcement. Although recessions are challenging, there are actions you can take today to help mitigate the potential long-term damage.
Credit Card Debt
According to LendingTree, the average annual percentage interest rate offered with a new credit card today is 21.59%. This is the highest interest rate since LendingTree began tracking rates monthly in 2019. There is no reason to pay this rate if there are other ways to pay for credit card debt.
It may be prudent to pay your monthly bill early so you can avoid being charged this outrageous amount of interest. If you need to borrow from somewhere else to pay credit card bills, it could mitigate the amount of interest you will pay. Home equity lines, brokerage margin accounts, or personal bank lines of credit will only cost 5-6%, a mere fraction of what credit card companies charge.
As tempting as it might be, try to avoid taking money out of your retirement accounts to cover your monthly bills. Your 401k account(s) and IRA(s) are for retirement only. There are substantial penalties for taking money out of retirement accounts before age 59 1/2. Early withdrawals are subject to inclusion when calculating gross income; additionally, there is usually a 10% penalty.
However, you may be able to use IRA funds to pay your medical insurance premium after a job loss. You can take a hardship withdrawal from your 401k if the plan is held by your employer. It may be best to leave your retirement accounts intact growing tax-free until age 72. At that point, you are required by law to begin taking annual withdrawals.
Adding to your 401k out of your bi-monthly paycheck, particularly if your employer matches, may be beneficial. You could also make the maximum annual contribution to your IRA at the beginning of the year if you are able. Additionally, you could split the maximum annual contribution limit between a traditional IRA and a Roth IRA, or just go all-in on either. If you expect your tax rate to increase in the future, a Roth IRA would be your best bet.
The general rule of thumb is to have some mattress money or cash to cover up to six months of living expenses. This money is set aside for the purpose of weathering emergencies. During a recession, you may want to increase this amount. If possible, stashing away a year or 18 months’ worth of savings for living expenses could help provide peace of mind.
The good news is that for the first time in years, you can buy the one-year treasury bond yielding over 3%. Better than that, you can buy I-Bonds, which are referred to as inflation-protected bonds. The current yield on I-Bonds is 9.62%; however, there are some limitations. You can only buy these bonds in $10,000 increments per individual family member in a given calendar year. Also, they can’t be redeemed for a year, and if you withdraw funds within five years, you will owe three months of interest.
Recessions give all of us a great excuse to cut back on our extra big-item spending. Ask yourself if you really need to take that trip, buy a new car, or remodel the house this year. Frankly, you probably don’t need to do any of those things. Now is not the time to take on extra debt or spend more than you make. If the recession lasts long enough, odds favor inflation coming back down, and if you can wait another year or two, airfare, new cars or remodeling expenses could be much lower than they are today.
Although economists have varying opinions about whether or not we are in a recession, the stock, bond, and housing markets are signaling that we are in one currently or are rapidly heading in that direction. We are in a bear market, the yield curve is inverted, and the bidding wars for new homes are long gone.
Now that you know this, it may help to curtail your spending on large-ticket items, pay off your expensive credit card debt, keep contributing to your retirement accounts, and save 12-18 months of your living expenses. Also, you could invest emergency cash into I-Bonds or the 1-year treasury bond. Recessions don’t last forever, but it is better to be prepared when they inevitably come.
Frederick Taylor is a Partner, Managing Director at Beacon Pointe Advisors, LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed. Past performance is not a guarantee of future results. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook, and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.