The next time the Bank of Canada (BoC) raises interest rates on the scheduled date of September 7, 2022, could potentially trigger a recession.
Red-hot inflation has been the story of 2022, and the BoC is stuck between a rock and a hard place: trying to control inflation by raising interest rates, which then runs the high risk of an economic downturn.
Although there may be a chance that we will not enter a recession and the BoC is still hoping for a soft landing, it is better to be prepared.
WHAT IS A RECESSION?
When many people think of a recession, they may remember the global financial crisis that happened in 2008, and the resulting chaos. However, recessions are not always that dramatic and can vary in severity.
There are many different definitions of what a recession is, but a simple one is given by the National Bureau of Economic Research (NBER):
A recession involves a significant decline in economic activity that spreads throughout the economy and lasts more than a few months. It can affect various aspects of the economy, such as real GDP, income, industrial production, employment, retail sales, and industrial production.
GDP is an important indicator of where the economy is potentially headed. Current statistics show that Canada’s GDP is very close to stagnation and has moved very little recently (0% growth between April 2022 and May 2022).
HOW YOU CAN PREPARE FOR A RECESSION
Recessions aren’t just bad for businesses; they are bad for everyone. During a recession, it’s common to see rising costs along with job cuts, pay cuts, stock market declines, and reduced income security.
It’s a good idea to start preparing for a recession now so you’re not caught off guard. Here are some practical tips you can employ to make sure you’re ready for the coming market downturn.
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1. Evaluate your current investments
The main question you should try to answer when analyzing your investments is: “How much risk am I exposed to?” Depending on where your assets are held, try to get a full picture of what you have and what your potential losses might be. You may need to check your self-directed financial statements, contact your financial advisor, or review your pension plan at work.
This will have a lot of variation between different people. For example, if you’ve invested in 100% Canadian stocks, look at worst-case scenarios, such as during the 2008 financial crisis, when the TSX fell 35%.
The next question to ask yourself is, “Am I willing to accept this risk?” If the answer to that is no, then it means your risk tolerance is potentially not a good match for your investments and you might consider adjusting it. Some de-risking strategies are investing more in fixed income, cash, or stocks in more stable sectors (such as utilities).
If you’re not sure what your current risk tolerance is, consider doing an investor quiz.
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2. Reduce your monthly expenses
When a recession hits, the first thing businesses do is cut their overhead. They can cut funding to departments, suspend salary increases, and prevent unnecessary maintenance.
Consider doing the same at home.
First, sit down and look at your monthly budget. It’s helpful to have a comprehensive view of all of your family’s expenses, including rent, mortgage, utilities, food, fuel, and entertainment.
It is very likely that you will find some areas where you can reduce your expenses. Evaluate the big three expenses in your budget: housing, transportation, and food. See if there is any way to reduce any of those areas.
During a recession, there is a greater chance of losing your job. If you own a business, you may have fewer customers renewing their contracts or fewer buyers buying your products. This can restrict your personal finances and make it difficult to pay bills.
During these periods, it is vital to have an emergency fund. Hopefully, you won’t have to use it. If the worst happens, at least you’ll have him there to help you get out unscathed.
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3. Develop your most valuable skills
During a recession, it is important to continue adding value. If you’re an employee, try to hone his skills and become the best at what he does so you’re less likely to get fired if there are rounds of layoffs. If you’re a small business, focus on being the best in your industry and providing exceptional service to your customers.
When money is tight, people and businesses will continue to invest in people and products that add value to them.
FINAL THOUGHTS
There is no way to predict exactly how long a recession will last, but we can look at history to get a rough idea. Canada has experienced only five recessions since 1970, and usually lasted between three and nine months. Unfortunately, there is little any of us can do to avoid a recession. By preparing ahead of time, we can limit a recession’s ability to hurt us financially.
By being smart with your money, increasing its value, saving where you can, and cutting out waste, you can survive and potentially even thrive during a recession.
Christopher Liew is a CFA Charterholder and a former Financial Advisor. He writes personal finance advice for thousands of daily Canadian readers on his Awesome Wealth website.
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