Six ways to recession-proof your finances

We are now officially in a recession – if only just.

Figures from the Office for National Statistic (ONS) show that gross domestic product (GDP) has shrunk for two successive quarters, the official definition for a recession.

Between October and December last year, the economy shrank by 0.3%, on the back of a 0.1% slip between July and September 2023.

Although this recession isn’t looking nearly as significant as those that followed both the global financial crisis and the pandemic, a shrinking economy is never good news.

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Businesses may see their profits fall during a recession with job losses more likely. Workers may struggle to get pay rises and reductions in spending mean the revenue the government earns from taxes drops, potentially leading to public spending cuts. During a recession, more people are also likely to rein in their spending and delay making major financial decisions, like buying a new home, starting a family or, even retiring.

While certain investors will spy opportunity in a recession, it’s a word that will understandably make others feel jittery and nervous.

But whatever position you are in, there are steps you can take to recession-proof your finances.

1) Build an emergency fund

Even if you aren’t worried about job losses it makes sense to have an emergency fund, in case your income takes a hit.

Experts typically recommend having at least three to six months’ living expenses in an easy access account at all times.

A good cash buffer is just as important if you are retired and using a drawdown pot to generate your retirement income.

Maintaining your income withdrawals while stock markets are falling will only exacerbate your losses. Not only will this reduce your pot’s capacity to generate an income in the future, it may also reduce its lifespan.

However, if you have access to cash and are able to pause your withdrawals until markets recover, you’ll reduce the pressure on your pension and give it the breathing space it needs.

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Recent increases to interest rates mean that the best savings accounts should still give you a pretty decent return on your cash. So, if you haven’t reviewed your accounts in a while, it’s worth shopping around to ensure you are getting the best interest rate possible.

2) Stay invested

We might technically be in a recession, but at the moment there’s no immediate need for investors to panic. Although the FTSE 100 is down over the last 12 months, at the time of writing, the UK’s main market was pretty much where it was in September.

However, even if markets do take a more substantial hit - a ‘correction’ describes drops over 10%, if it’s 20% or more and we call it a ‘crash’ - it’s important to avoid knee-jerk reactions.

Pulling out of the market normally only serves to crystallise your losses and means you miss out on the opportunity to recoup them when the recovery inevitably begins.

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3) Review your strategy

While you shouldn’t cash in your investments during a recession – or a period of stock market volatility – that’s not say you shouldn’t review where your money is invested.

If you are worried about stock market falls and the impact that could have on your investments, then you might want to consider moving into lower risk holdings or investing more defensively in areas that are better placed to hold steady in a recession.

This often includes manufacturers of household staples and healthcare. Think about the sort of consumer goods people will continue to buy, irrespective of what’s going on in the economy – like nappies, baked beans and teabags.

But this still isn’t a decision to rush into and a major strategy review is only likely to be merited if you’re going to need to access your money soon (for example you are in, or approaching retirement) or your investments are literally keeping you awake at night.

Some investors will try and find opportunities to buy during a recession – scooping up shares at rock-bottom prices in the hope of recovery. But this is much higher risk and something you should only consider if you can afford to speculate.

4) Ensure your portfolio is diversified

Reviewing your strategy shouldn’t just be about checking your investments are in line with your current attitude to risk. You should also check it’s sufficiently diversified.

There isn’t anything wrong with investing in UK small companies during a recession, but you might not want to stake your retirement on it either. The key is to balance out your riskier holdings with lower-risk investments. A well-balanced portfolio should include fixed interest investments (like corporate bonds or gilts) and equities – with exposure to companies of various sizes with good geographical spread. By not putting all of your eggs in one basket, you reduce the risk of one poor performing investment having a big impact on the overall performance of your portfolio.

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5) Invest regularly

Paying lump sums into the stock market can be higher risk, especially during a recession or when markets are volatile. That’s because you’re putting a lot of money on the line in one go and its value could fall quickly if you invest just before a stock market correction.

This risk can be avoided by drip-feeding money into the stock market on a regular basis. By investing regularly, you get to take advantage of pound cost averaging. This means that the shares will be a different price each time you buy them, so rather than buying all your shares when prices are high, or all of them when they are low, you end paying an average price for them over time, smoothing out your returns.

Investing regularly can be particularly beneficial when stock markets are volatile as you’ll get more shares for your money when prices are low – leaving you with more shares to benefit from when prices tick back up.

Another plus to regular investing – if you have a monthly payment set up – is that you don’t need to consider timing your investments, which can be tricky when you are contemplating a larger lump sum.

6) Don’t neglect your pension

Keeping with the theme of regular investing, it’s important to carry on saving in a pension, whether your finances are feeling squeezed or you are worried about potential stock market volatility.

Pension saving doesn’t just benefit from a regular investment strategy, one of the biggest drivers of your pension’s investment growth is the tax relief you get on your contributions.

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This is equivalent to the rate of income tax you pay, and it means it only costs £80 for a basic-rate taxpayer to invest £100. Higher and additional rate taxpayers only need to pay £60 and £55 respectively to invest the same amount.

This is an instant return on your cash, before you even factor in what’s happening on the stock market.

And, if you stop making pension contributions or scale them back, you’ll miss out on this valuable top up. Even if money is tight, it will make more sense to examine your spending and identify other ways to free up some cash, before reducing what you’re saving for retirement.