Guest post by Matt Collins
For those of us who are old enough to have experienced the Great Recession in our adult life, the thought of another economic crash occurring is a very real worry. Even the most prepared individuals felt the effects of a crashing economy in the years between 2007 and 2009. Some of us still haven’t fully recovered. Although the possibility of another recession is always in the air, unfortunately, most people are less prepared today than they were before the Great Recession began. If the economy were to crash tomorrow, could your finances survive?
If the answer is, “I’m not sure”, you should definitely continue reading. In the following post, we will present five questions to test your financial preparedness and help you to get completely ready for an unexpected economic future.
Do You Spend Too Much On Your Debts?
Truth is, many people are simply overextended with their debts, using their credit as a way to live beyond their comfortable means. Even in an economic recession, your debts will not stop and your debtors likely won’t “give you a break.” If you lost your job today, would you be able to afford your debts next month or would you suddenly find yourself having a hard time keeping up with your mortgage and car note?
Many financial consultants recommend a debt-to-income ratio of 1:3. This means that your debts should be equal to or less than 33% of your monthly income. This rule ensures that if you were to become unemployed today, you would still be able maintain your debts with only ⅓ of your current income.
What To Do About It
Assess your monthly debts and compare them to your monthly income. If your debt-to-income ratio is already lower than 33%, great, keep it that way. On the other hand, if you find that your ratio is higher than this, here is some advice:
- Pay Down Your Debts: The most obvious way of decreasing your debt-to-income ratio is to maintain your income, while decreasing your debts. Examine how you spend your money each month. Identify areas where you can save money (eliminate or decrease cable services, etc.) and use this extra money to make additional payments on your debts. Every debt that you are able to eliminate equates to one less worry in the event of another economic recession!
- Refinance for Better Interest Rates: High interest rates that you carry on your debts can add significantly to your debt-to-income percentage. Work on improving your credit so that you can refinance your mortgage and car loan debts for better rates. Speak with banks and other credit card providers to see if one of them will offer you a credit card with a lower interest rate than what you are currently receiving.
How Large Is Your Emergency Fund?
Unfortunately, for many people, the answer is “not large, whatsoever.” According to a GoBankingRates survey, 35% of all adults in the U.S. only have “several hundred dollars” in their savings account and 34% have no money at all in savings. It is generally recommended that you keep 3-6 months of income in your savings as a safety net, in case your income becomes restricted for any reason. While this is a great start, is it enough? The Great Recession lasted two whole years, and the effects, much longer. During this recession, many people found themselves without a job for much longer than 3-6 months. Some financial advisors, like Suze Orman for example, suggest an emergency fund equal to at least 8 months of your income.
What To Do About It
Do you have eight months of savings put away? If not, here are a few tips to build a big enough nest egg to sustain you during a recession:
- Set a Savings Goal and Stick to it: People who do not have savings put away usually reason that they do not make enough income to save. The truth is however, you can save at any income level if you set a goal and stick to it. Even if you can realistically only save $150 per month at your current income, saving that money on a consistent basis will help you build stronger money management skills. Put this money into a savings account and don’t touch it under any circumstance. As your nest egg grows each month, you will continue to increase your chances of surviving another economic recession.
- Use an Automated Savings Program: With today’s technology, it is possible to automate your saving to make the process easier than ever. Apps like Acorns automatically round up your debit card purchases to the nearest dollar and invests these funds into a low-risk investment account. By using an automated savings program, you can begin building your nest egg without putting in much effort or thinking too much about it.
Do You Have Enough Credit Available?
Recessions often lead to job layoffs, and with unexpected layoffs there is always the possibility that unemployment will outlive your emergency fund. Survival may come down to your ability to access credit. However, if all of your credit cards are already reaching a “maxed out” state, you will have no credit available to sustain you in the case of an emergency. Keep your credit usage low and maintain a large gap between the amount of credit that you have used, and the amount that you have available.
What To Do About It
Do you have enough credit to sustain you in case your emergency fund runs out? Here are a few tips to help ensure your survival:
- Pay Your Cards Down: If you currently have a high credit usage ratio, focus on paying it down as quickly as possible. Use your cards infrequently to ensure that you maintain a low credit usage percentage.
- Keep a Backup Line of Credit: Take out a credit card to be specifically used for an emergency situation. Keep it locked away in a desk or a safe so that it will be available if a critical situation ever arises.
Are Your Investments Diverse Enough?
A diverse portfolio can be a lifesaver during an economic crisis. If your portfolio is weighted too heavily into one type of investment, and that investment tanks during a recession, your nest egg can quickly lose considerable value. Evaluate your portfolio and make sure that your money is spread across various investments. This way, you can ensure that if one investment fails or falters, there are several others that you can rely on to maintain your portfolio’s value.
What To Do About It
Could your portfolio use some diversification? Follow the tips below to prepare your portfolio to withstand the financial heat during a critical situation:
- Use Investment Software: Consider doing more than just keeping a 401K. Use programs like Betterment to automatically invest in bonds and other less-risky investments.
- Know When to Get Out: Keep an eye on all of your investments and know when those investments are no longer healthy for your portfolio.
Do You Have Multiple Streams of Income?
In the same way that you should diversify your investments, you should also look to diversify your income streams. By having additional income streams, you become less reliant on a single source of income, giving you a level of protection if economic conditions results in a layoff from your employer.
What To Do About It
How will you earn money if you are laid off from your job during an economic crash? Here are a few tips to generate additional and supplemental income:
Evaluate the Value of Your Assets: If it came down to a situation where you needed to liquidate your assets to survive, how much money would you be able to generate? Take an inventory of everything that you own, and evaluate how many months of survival you could expect if ever became necessary for you to take this route.
- Evaluate The Value of Your Assets: If it came down to a situation where you needed to liquidate your assets to survive, how much money would you be able to generate? Take an inventory of everything that you own, and evaluate how many months of survival you could expect if ever became necessary for you to take this route.
- Set Up a Side Business: Consider the things that you are really good at doing, and figure out a way to monetize these skills. If you have skills that may be valuable to small businesses, use freelance sites like Elance or Fiver to sell your services. Check out marketplaces like Etsy if you have a knack for producing handmade items. Put ads on Craigslist for local services that you can offer. Anyone can make an additional income with a bit of creativity, the internet, and some dedication.
Just Get Started
You know that you are ready for anything when you can answer “yes” to each of these questions. Don’t stress if you’ve missed the mark, just start working on improving your situation immediately. While financial experts can make predictions, nobody knows exactly when the next critical economic situation will occur. Each day that goes by that you do not progress your financial-readiness, your potential for financial survival during a recession decreases. The ability to survive is totally in your hands - when the time comes, make sure you are ready!
Matt Collins is a financial educator and the owner of Loans Now. With over 15 years in the personal finance industry, he has worked with thousands of individuals to help improve their financial situations and secure loans during emergency situations.