Recession : Impact and money management

26 July 2022 by National Bank
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When the economy falters, a recession can follow. Recessions drag down the whole economy, but what about you personally? What impact could a recession have on your personal finances? Here are some tips to protect yourself from an economic downturn.

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What is a recession?

Simply put, a recession is any two consecutive quarters where gross domestic product (GDP) is lower than the previous quarter.

In reality, though, Canada has a committee that analyzes a number of economic factors to decide whether we can really and officially say that we are in a recession. It looks at the big picture. How long is the recession going to last? What is the breadth of the economic downturn? How serious is it?

What causes recessions?

Each recession has one major cause and a number of minor ones. Generally, something has disrupted the economy such as an overly restrictive monetary or fiscal policy, a pandemic, the bursting of a bubble or a problem with a natural resource such as oil.

How do recessions affect the economy?

There are a few things that happen during a recession. It’s like a chain reaction, with each consequence leading to further consequences. Each time is different, but generally speaking things like companies, securities and resources begin to drop in value as consumer spending slows. This can cause job losses and lead people to be more cautious and to consume even less, and so on.

What impact can a recession have on my personal finances?

A recession could have a direct impact on your finances. Here are a few things that could happen and ways to limit a recession’s impact.

The policy interest rate

The Central Bank of Canada may want to head off or blunt a recession by adjusting its policy interest rate. This results in a change in interest rates for loans and investments. The goal is to influence spending in order to control inflation.

Credit risk

Higher policy rates have a direct impact on the interest charged on certain loans or business debts, but also on interest you may have to pay. For example, your budget may contain items you’re already paying interest on. If rates rise, your payments could rise too and affect your finances. This is called credit risk.

The most common example is your mortgage. If the rate’s not locked in, you could find yourself paying a lot more interest. You can learn more about the impact of a policy interest rate hike here.

There may also be consequences if you have a fixed rate mortgage that is coming up for renewal. For the same home with the same loan, you could end up paying hundreds of dollars more each month just because the rate rose a little bit.

Interest rates on personal lines of credit may also increase depending on the terms of your agreement with your lender.

If economic trends point to rising rates, it is advisable to plan your budget and cash flow so that you can pay off all your debts without penalty.

The specialists who set up your loans can help you assess the risks and implications of rising rates. They can also help you find a solution if it has become difficult for you to repay your debts.

The value of investments

Whether a recession is underway or not, fluctuating markets often lead investors to question their investment choices. However, it’s important to keep your original objectives in mind and stay focused on achieving them. Markets always go up and down, but their long-term trend is positive. Here are tips on how to manage your investments through an economic downturn.

Job loss

A job loss will have an impact on your finances in the short term, but there are ways to limit the consequences in the medium and long term. Adjusting your expenses and carefully managing your savings will help protect your finances if you lose your job.

Can I prepare for a recession?

No one can prevent a recession. However, you can have a plan ready to deal with one. With good financial planning based on your objectives and profile, you should see your way through any market fluctuations without having to make changes.

Of course, you might want to ask your financial experts how diversifying your portfolio can take the worry out of a recession.

Good to know:

 It’s always best to have an emergency fund—money you’ve set aside for a rainy day. This is an account where you keep enough money to meet your needs for a few months. There are several ways to create an emergency fund.

How can I protect myself financially during a recession?

The best thing is to stay focused on your investment goals. Selling while the market is down out of fear it may drop further could simply lock your losses in. Yet it’s often possible to make up losses over time just by waiting.

You may feel compelled to keep your wallet closed and spend less. But if everybody does that, it just makes the recession worse—declining spending is one of the root causes. Remember that responsible spending and regular savings are behaviours you should adopt at all times—there is no particular reason to try to save more during a recession.

Even if a recession can feel scary. You may not feel the financial impact too much if you already have good consumer, credit, savings and investment habits. If in doubt, talk to your financial advisor. They can help you decide what’s best for you. We’re here to answer your questions.

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