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With a notable number of high-profile company layoffs and a lower rate of inflation, you may be wondering whether you might feel the effects of a recession in the U.S. economy in 2023 and what you can do to protect your money if there is one.
Recessions are marked by a prolonged economic downturn, which is often defined as two quarters in a row when the U.S. has negative economic growth. This happened in 2022, but experts seem to disagree on whether the U.S. is experiencing the full effects of a recession, where inflation decreases, consumers spend less money and some businesses lay off employees to stay afloat.
If you’re worried about the impact that a recession could have on your savings, here are some things to consider.
How does a recession affect my savings?
The good news is that since the rate of inflation slows during a recession, the value of your money either stays the same or slightly increases, which means your purchasing power improves. For your savings, that means the value of your cash is greater than when there’s high inflation.
On the other hand, when inflation slows, the Federal Reserve typically responds by decreasing interest rates, which typically increases consumer spending since it becomes cheaper to finance purchases. Unfortunately, however, interest rates on bank accounts also usually decrease when this happens, so you begin to earn less interest on your money.
How an emergency fund can help
Emergency savings are good to have no matter what is going on in the economy because unexpected expenses — such as a car repair or medical issue — can arise at any time. It’s especially important to have savings during a recession, however, because economic uncertainty can create other financial concerns, such as layoffs. A surprise job loss can be stressful, but if you’re cushioned with an emergency fund, it can be easier to pay for your expenses until you get a new position.
Katherine Heeren, a blogger and creator of The Nimble Budget planner, says that when her husband was laid off from his aviation-industry job in 2020, they were grateful that they had been preparing for potential job loss based on the economy, and they had been testing out their lean budget.
“We did the math to determine how many months we could get by comfortably,” Heeren says. “We didn’t just wait until the inevitable happened. We cut out discretionary spending, and we were able to save even more for our emergency fund.”
When her husband was laid off, Heeren and her family were already living well below their means, forgoing unnecessary expenses like new clothes and salon visits, with months of savings stocked up.
How can I increase my emergency savings?
Calculate how much you’ll need
A good rule of thumb is to have three to six months’ worth of expenses saved up in case of an unexpected job loss. You can calculate your emergency fund by looking at your monthly spending and subtracting any nonessential purchases, then multiplying by however many months of savings you want to have. If that number seems out of reach for now, start with $500. This amount should be able to help you weather minor emergencies, such as a home appliance repair or a trip to the vet.
Cut nonessential spending
“The easiest tactic to save more is to figure out how much you’re currently spending,” says Howard Dvorkin, a certified public accountant and chairman of Debt.com. “Once people look at their spending, they’ll see there’s usually 15-20% of spending on things that aren’t necessary, like subscriptions you don’t use.”
Dvorkin suggests that people take that unnecessary spending and use it to shore up their savings and other financial goals to prepare for economic uncertainty.
Pay off high-interest debt
Dvorkin adds that debt can be a major blockage to financial health during a recession.
“If you have credit card debt, it’s really hard to put away emergency savings,” Dvorkin says.
In addition, he says that if you lose your job, you don’t want to rely on credit cards, home equity lines of credit or your retirement savings, since those options just create more financial stress and obligation than having savings.
Open a high-yield savings account
A high-yield savings account will help you earn much more than the average rate of return, which means your money will work harder for you. Even if interest rates dip during a recession, a high-yield savings account will typically earn several times the national average for savings accounts. The national average is 0.35% annual percentage yield, and some high-yield accounts are currently offering 4% APY or more. If you have $10,000 in a high-yield account, that means you could earn $400 in interest compared with $35 in an account paying the average rate.
Automate transfers from every paycheck
To make saving easier, ask your employer to split your paycheck into both checking and savings when you get paid. That way you won’t feel as tempted to spend the money that you want to set aside for an emergency fund.
This time of year, if you’re getting a tax refund, consider sinking it into your emergency fund. Similarly, if you get a raise at work, consider saving the new income and maintaining your same living expenses.