Luke Delorme: Preparing for Recession: Steps 2 and 3

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This is the second in a series of occasional columns about planning in the event of a recession.

Several economic indicators, including an inverted yield curve, suggest a recession is becoming more likely in the not-too-distant future.

Recently, I discussed the importance of budgeting, especially for those workers most susceptible to a downturn in the economy (construction, real estate, restaurant and hotel employees, retail workers). This week, I look at steps two and three in preparing for recession: tackling debt and establishing savings. Next, I will look at structuring an investment portfolio.

Managing debt

Any time is a good time to tackle debt, but right now is a great time to start to get debt under control.

First, if you have any high-interest-rate debt, such as credits cards, you should do everything in your power to pay them off ASAP. This goes back to step No. 1 about budgeting — reducing expenses will afford you greater opportunity to pay down credit card debt.

Although credit card debt can be overwhelming, isolating debt into bite-size chunks can help you make progress. You may start with a credit card with a low outstanding balance and put an extra $50 or $100 toward it every month, which may be possible if you've shored up your budget. That little bit of positive momentum can carry over into other facets of your financial plan.

If you have outstanding student loans and car payments, now might be a good time to put a little extra toward those loans in hopes of getting them off your books and reducing expenses in the future.

Finally, if you have a mortgage or other longer-term debt, now could be a really great time to refinance at a lower rate. Interest rates have fallen to historic lows once again, which presents an opportunity to re-finance debt. Depending on your current interest rate, refinancing can potentially shorten the life of your mortgage, reduce your monthly payments, or both.

If nothing else, moves such as these can create positive momentum in our financial lives. It could be something as small as emailing a mortgage broker or calling your bank to check on refinance rates to get the ball rolling.

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Emergency savings

After you've established a sound budget and tackled debt, the next step is to establish savings. These accounts are held in cash, money markets, or short-term debt that is dedicated strictly for emergencies that arise.

How much to hold is not a perfect science. One rule of thumb is to keep the equivalent of somewhere between three and 12 months' expenses in savings. If you're spending $3,000 per month, this would suggest a savings bucket between $9,000 and $36,000, a wide range.

The right amount to hold in this reserve will depend on a number of factors: job security; how many people work in your house; health care needs; and how many people are dependent on your income. There is also an important behavioral factor — how much do you need to sleep soundly at night?

At the end of the day, you should try to have savings in place before the next recession, whenever it might come and however severe it may be. It is always prudent to set something aside, but if you think that your income might suffer during an economic downturn, it would be wise to hold a little extra. However, it's probably more important to tackle your credit card debt than it is to build savings.

Next steps

Managing debt and establishing an emergency account are good ideas in any economic environment, but become even more important as the likelihood of recession rises. After you've established a sound budget, you can potentially put excess income toward debt, and eventually create more savings.

These three items — budgeting, tackling debt, and establishing a savings account — are interrelated. Although it can be intimidating to start any financial plan, creating actionable bite-size chunks will eventually amount to a robust plan. We encourage anyone to start with small wins, such as reducing your phone service or limiting dining out to one or two times per month. Be creative — imagine having a celebratory dinner at home, topped by transferring the $200 you just saved into savings!

Next time, I'll look at developing a robust investment plan that should allow you to grow wealth over time and not panic during a recession.

Luke Delorme is director of financial planning at American Investment Services in Great Barrington. He can be reached at luked@americaninvestment.com. Past performance is no guarantee of future results. This information should not be considered investment advice or a solicitation to buy securities. A professional adviser should be considered first before implementing the options presented.


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