Smart Ways to Make Your Finances More Recession-Proof

Markets may rise and fall, but your finances don’t have to bounce around as much.

As it stands, the economy looks uncertain. Record-high inflation makes everyday purchases more expensive. To try to tame inflation, central banks have been raising interest rates. Yet doing so introduces new pressures, like making new mortgages and business loans more expensive. Altogether, that raises the risk of a recession.

Until inflation gets under control for a prolonged period, volatility and uncertainty may remain high. Plus, the pandemic and Russia-Ukraine war continue to impact the global economy.

While these factors are outside your control, you don’t have to sit back and hope for the best from a personal finance perspective. Instead, you can take charge of your own savings, investments, and income streams to become more recession-proof.

As we’ll explore in this article, you can take several money management steps to thrive in any environment.

Take control of your spending

You’re likely all too aware of inflation when it comes to gassing up or feeding your family. However, another type of inflation might have emerged more discreetly—lifestyle inflation.

As someone’s income goes up, their expenses tend to rise, too. Renting an apartment gives way to buying a house. A used sedan turns into a new luxury SUV.

The looming risk of a recession is a good opportunity to re-evaluate your cash flow. Review recent credit card and bank statements to see how your spending compares with your income. Consider the 50/30/20 rule of thumb: 50% of your after-tax income goes toward needs, 30% goes toward wants, and 20% goes toward savings or debt payments. If you don’t have that buffer of around 20%, an economic downturn is more likely to slash your income below your expenses. Or, continued inflation could push those expenses above your income.

To avoid having to dip into savings, sell investments, or take on debt to afford your lifestyle, see what expenses you can reasonably cut. For example, you might have a country club membership you rarely use. Or maybe you have season tickets for a sports team, but end up giving away your seats for most games.

Cutting those costs gives you more flexibility. You can save more for goals like paying for your children’s college tuition. You can invest more to retire sooner. And if your income stumbles, you won’t have to panic.

You don’t need to live frugally, but you don’t want to be frivolous either. Take your dream vacations, for example, but be mindful of the costs. Maybe you’ll wait until you have enough credit card points to cover airfare.

Getting a good handle on your spending now and being aware of lifestyle inflation also means that as your income rises in the future, you’ll be better prepared to use that extra money for major life goals, rather than what feels like ordinary expenses.

Diversify investments and income streams

Another important money management strategy is diversification.

Suppose you invested a significant portion of your portfolio in your company’s stock. Or maybe you’re waiting to cash in stock options. If most of your money is tied up in one area, then a recession-related crash could put you in a precarious position.

Then, a recession causes you to lose your job, while the company stock stumbles. If you only have that one income stream, you might be forced to sell your stock when prices are far lower than what you paid. Or, you might not be able to cash in your options if they don’t reach the strike price due to the downturn.

Instead, suppose you built a portfolio of investments in multiple asset classes. If you have to make up for lost income during a recession, you don’t necessarily have to sell assets at a loss. Perhaps your stock investments are down, but gold or fixed income investments are up. So, you could sell the winners and hang onto the assets that need time to recover.

Whatever the scenario may be, having a mix of stocks, bonds, real estate, commodities, etc., means you’re not as dependent on any one area. Within these asset classes, try not to put all your eggs in one basket either. Markets might not always move the way you expect, and you still might experience some dips. Diversification does not assure an investor a profit, nor does it protect against market loss.

For example, McDonald’s had a volatility of 11% over two years, making it the least volatile stock in the Dow Jones Industrial Average (DJIA) for the measured period. "But the volatility of the DJIA as a whole was only 9%—less, in other words, than the volatility of its least volatile component," finds an S&P Dow Jones Indices analysis.¹

"Investing in a large number of stocks reduces the unsystematic (idiosyncratic) risk, i.e., the risk specific to a given company, and consequently reduces the volatility of the portfolio," note researchers in a study published in the Journal of Risk and Financial Management.

The current market environment also underscores the value that investments like capital-protected structured products and absolute return strategies can provide. Depending on your personal finance goals and risk tolerance, you might want to put a slice of your portfolio in these types of assets that can limit downside while still offering upside potential.

Aim to diversify income streams too. Managing spending isn’t the only way to protect savings from inflation. If you have multiple sources of revenue, you can reduce the risk of having to tap into your savings. In some cases, investments can provide additional income streams. Directly investing in real estate, for example, could provide rental income, along with the potential for underlying housing price gains. Or, you might invest in a real estate fund or other assets that pay dividends, providing you with some additional income you can use to offset higher bills due to inflation.

Keep investing during downturns

When the market stumbles, your first instinct might be to retreat. But you generally want to stay the course. Otherwise, you could lock in losses by selling low and end up buying high once the market recovers.

That said, you may want to adjust your risk levels. Now might not be the best time to take a gamble on a startup business, for example, if you’re looking to become recession-proof. If revenue slows down due to a recession, companies like these might have trouble meeting their financial obligations.

Instead, as Santander notes in the Q3 2022 Global Market Outlook, uncertain times like these call for a more moderate level of risk. Look for profitable companies that have the following characteristics:

• Strong cash flow
• Low debt and liquidity needs
• High, stable margins

Continuing to invest during downturns could also help you ride out volatility and grow long-term wealth by lowering your cost basis for investments. Here is a hypothetical example to help illustrate how it may work. Remember, actual results will vary and to consult with your attorney and accountant for advice.

Suppose you put $1,000 into a brokerage account every month. In August, let’s say you bought 10 shares of a fund at $100 per share. By September, perhaps the fund fell to $90, so your $1,000 investment allows you to purchase 11 shares (aside from any fractional shares).

So, instead of your average price per share being $100, continuing to invest during the downturn brings your average to roughly $95 per share. Even if the fund just gets back to its previous level of $100, you’ve made money in that scenario.

Plus, investing during downturns presents opportunities to scoop up assets at discount prices. When other investors panic or sell assets out of necessity, that puts downward pressure on prices. Then, you can use your positive cash flow to invest at a lower cost basis than before a downturn.

Take the long view

Making your finances more recession-proof also requires a long-term outlook. Seeing your portfolio drop can be unsettling, but remember that those losses are unrealized until you sell. If you can avoid panic trading and internalize that markets tend to recover eventually, you can wait until those losses become gains.

Not convinced? Look back at previous market downturns. In February 2020, near the start of the pandemic in the U.S., the Dow approached 30,000 points. Toward the end of March 2020, the index lost around a third of its value. But by the end of 2020, the Dow surpassed its previous highs. Even as the market stumbled in 2022, it has generally remained significantly higher than pre-pandemic levels.

Not all recoveries happen so quickly. During the Great Recession, global stock markets took a few years to regain what they lost.

If you take a long-term, multi-year outlook, avoid panicking, and continue to invest, you’ll generally be better off than if you try to time the market. Combined with money management tips like being mindful of lifestyle inflation and achieving diversification, you can be better prepared to handle whatever comes next.

To learn more about navigating uncertain markets and tap into expert advice, please reach out to our team of relationship bankers at Santander Private Client or financial advisors at Santander Investment Services.