Surviving a Recession

According to the National Bureau of Economic Research, the United States entered a recession in December 2007.  And while economists might define a recession as a reduction in a country's gross national product, indivdual families might be faced with financial hardships, including the loss of a job.

In this article, we're going to provide some tips that can help families survive a recession.  As part of that explanation, we're first going to describe what you can expect to happen during a recession.  By first gaining this knowledge, it will be easier to understand how to create a plan that allows you to survive a recession.

Economic Recessions

If you ever studied macroeconomics in school, then you might remember that a recession is defined as the contraction, or shrinking, of a country's gross domestic product - which is the value of all the goods and services produced by a country each year.

A less formal definition for a recession, and one that's used by the National Bureau of Economic Research, is a decline in economic activity lasting for more than a few months.  During a recession, we can expect to see a reduction in corporate profits, an increase in unemployment, and a decline in investment activities.

Unemployment Rates during a Recession

As the economy contracts, consumers begin spending less money on goods and services.  As corporate revenues begin to decrease, there is subsequent downward pressure on corporate earnings.  In an effort to increase profitability, companies begin to cut expenses including their labor costs.  Therefore, there is a direct correlation between recessions and a decrease in wages - whether this is through the loss of a job or a reduction in overtime.

Information obtained from the Bureau of Labor Statistics, allows us to demonstrate the affect recent recessions had on unemployment rates:

Even more alarming for some is the long-term unemployment rate.  We're defining long-term as persons unemployed for 27 weeks or more.  Here we also find an interesting fact from the recession of 1980 - 1982:

In June 1983, seven months after the official end of the 1981-82 recession, the long-term jobless rate peaked at 3.1 percent, the highest recorded in the post-World War II era.

Studies have also shown that during recessions, employers will reduce the amount of overtime offered to workers.  Once again, information from the Bureau of Labor Statistics tell us that during 1980 - 1982 recession, manufacturers of durable goods reduced overtime hours by 84.2%.

Tips for Surviving a Recession

The challenge of surviving a recession involves both understanding what to expect as well as being prepared for the worst.  The loss of a job is one thing, but a recession is usually accompanied by a drop in the prices of stocks too.

If you happened to lose your job during a recession, then you're going to need another source of income to pay your monthly bills.  All good investors know that selling stocks at the tail end of a bear market is a losing proposition.  (Remember, recessions and bear markets often coincide.)  So the worst-case scenario for anyone hit hard by a recession is this:

• You've lost your job
• You're selling the stocks you own at bargain (low) prices

That's why the word recession is synonymous with terms like "cash crunch."  And with that introduction, here are our tips for surviving a recession.

Start Saving Money

Our first tip is the most important piece of advice that can be offered - start saving money now.  You need to follow the philosophy of "paying yourself first" or you'll never have enough cash to make it through a recession without going further into debt.

If you're having trouble making ends meet, and think it's impossible to save any real money each month, then you need a reality check.  Throughout this publication, we have articles on building a budget as well as tools such as online budget calculators that can help you separate truly essential expenses from discretionary ones such as eating out.

When figuring out how much cash you need, the rule of thumb would be to have enough money saved to pay for at least six months of expenses.  If you've never created a budget before, and you don't know how much you spend each month, you have some homework to do.

Refinance Your Mortgage

In an effort to stimulate the economy during a recession, the Federal Reserve will often reduce interest rates.  By doing so, the federal government hopes that by making money less expensive to borrow, companies will begin to expand their operations once again through long-term capital investments.  That's good news for companies when they're struggling, but that's also good news for individuals too.

If you find yourself struggling to meet ends meet, or you'd like to save more money each month, then you might want to consider refinancing your existing mortgage.  The coincidence of lower interest rates and the ability to extend the timeframe over which you're paying your mortgage is a tempting combination.

This doesn't mean a recession is a good opportunity to increase your debt load.  What you're trying to do is reconstruct your existing mortgage and spread out your new payments over a longer timeline.  You'll find plenty of mortgage calculators on this website that can help you understand exactly how much money you can save each month by refinancing your mortgage.  The idea is to use the money saved each month to start building a "recession" fund.

Borrowing Against Retirement

Finally, it's never a good idea to borrow money from a 401k plan, which is your future, to pay for expenses today.  However, if the decision is between losing your home and borrowing money from yourself, the choice is clear.  Each plan may have slightly different rules, but the IRS allows for 401k hardship withdrawals under certain conditions, including:

• Money used to pay certain medical expenses for you, your spouse, or any of your dependents.
• Payments of specific post-secondary education expense for the next year for you, your spouse, or any of your dependents.
• The purchase of a primary residence.
• Money needed to prevent eviction or foreclosure on your primary residence.

Hardship withdrawals made under a safe harbor provision may exclude you from contributing to your 401k plan for six months or more.  Federal income tax on the hardship withdrawal may be deferred until age 59 1/2, but a 10% penalty may still apply.

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