How to Budget Wisely during a Recession
Budgeting during a recession is different than budgeting in a strong, growing economy. I originally wrote this article on the WorthyNest® blog in July 2020 as COVID-19 cases were rising across the US and internationally. There was a lot of uncertainty not only about the economy but also from a health perspective.
When will a vaccine safely protect us?
When can kids safely resume school in a physical building?
And while COVID-19 subvariants continue to circulate globally, many people have tried to go back to a “normal” standard of living … dining out, listening to live music, and gathering with family and friends.
Today’s questions are more like this:
Does a bear market always lead to a recession?
Are we in the middle of a recession?
Should our investment mix change?
Although I don’t have a crystal ball, I do have some insight into those questions as a CPA financial planner.
First, a bear market doesn’t necessarily lead to a recession. A bear market is a prolonged drop — typically 20% or more — in investment prices (i.e. a broad index such as the S&P 500 falls in value). A recession, however, is a macroeconomic term to describe a significant decline in economic activity over several months or years, looking at metrics such as Gross Domestic Product (GDP), unemployment levels, and real income.
To address the second question, we could be in a recession but not know it. The National Bureau of Economic Research (NBER) officially declares recessions and used to define a recession as two consecutive quarters of economic decline. COVID-19 changed the definition, with the shortest-lasting recession on record happening in March and April 2020. Recessions are backward-looking.
And lastly, your investment mix shouldn’t be correlated to a recession. Instead, read my article “Conquer 2022 With Bear Market Investing Strategies” to learn investing principles depending on your life stage.
There are only so many things within your control, and cash flow planning is one of them … regardless of whether we are officially in a recession or not. Budgeting wisely is crucial during your wealth-building journey.
CASH FLOW PLANNING
You already know the main types of budgets: the envelope budget and the detailed budget. Let’s move on to the practical application.
There is no perfect one-size-fits-all budget. A cash flow plan will be unique to each family. Shifts in income merit a change in plan.
If you haven’t already, download the detailed budget template from the Resources section here. This is your starting point and should capture your current income and expenses.
Next, add a new “Annual What-If” column to project how things will look in the future. Put the new income assumptions in the top section.
Perhaps your job is “safe” but you want to reduce your hours. Or you may be an entrepreneur in an industry that experiences substantial income drops during a recession. Anticipate how scaling back at work or a lower owner profit will look over the next twelve months.
Cash is king now and especially during a recession. There are two levers to pull in a personal budget: Income and Expenses. Today may not be the best time to ask for a raise if your employer recently initiated a hiring freeze. Do you have any way to increase your income through side hustles?
A careful review of expenses is also in order if you’re seeing a big income reduction.
EXAMPLE 1: VOLUNTARY REDUCTION
Let’s suppose you are working full-time now and earning $80,000 annually. However, you need a more flexible work arrangement to care for an aging parent. You talked to your boss and they are open to having you cut your hours in half to 20 hours weekly. This means you will earn only $40,000 annually.
The original “Annual” column would show $80,000 of earnings, while the new “Annual What-If” column should show $40,000 of earnings. Be sure to consider the impact of this voluntary reduction on other expenses.
For example, your tax bill will decrease. Think about federal and state income taxes in addition to FICA and Medicare. You may also lose access to employer-provided benefit plans such as health insurance and long-term disability coverage. Your 401(k) match may be impacted, too. All of these items are located in the “Other/Annual” Expense section.
Your fixed expenses may stay the same unless you tithe and have moved charitable contributions to this section. Two other possible exceptions within the Fixed Expense section are schooling and childcare costs. These apply if you previously sent your child to a private school and paid tuition or participated in after-school programs.
Discretionary expenses should be the focal point if you’re looking to reduce your overall cost of living during a recession. You are likely doing more activities at home and thus not spending much money on entertainment. Home-cooked meals cost less than fast food or sit-down meals.
You can also look at travel & vacations as another area to cut. Even with higher gas prices, driving a short distance within your state is more cost-effective than flying cross-country and reserving a rental car.
The beautiful part about budgeting is that YOU get to decide what is important. Family values continue to hold significance throughout this budgeting process.
EXAMPLE 2: SMALL BUSINESS OWNER
Let’s turn to another example.
Suppose you are an entrepreneur. Your business survived 2020, thanks to relief from the Paycheck Protection Program (“PPP”) and individual stimulus checks. Business was good in 2021 and close to pre-pandemic levels, so you hired additional staff to manage the extra workload. But you’re starting to see a shift. Revenues are declining.
To guard your business against further damage in a recessionary environment, there are a couple of things you should proactively plan for in the upcoming months.
First, consider the cash shortfall your business may have for the next twelve months. How can you make expense cuts in the business while still providing the same value and service to customers? Are the new hires all valuable members of the team, or will a revenue decline provide an opportunity to utilize a smaller efficient team? There will be less money available to pay yourself as the business owner, and this impacts the Income section of your personal budget.
Follow a similar protocol to the first example when you evaluate personal expenses. Discretionary expenses should be carefully reviewed to see if you can forego a luxury that does not have much meaning to your family.
As you can see, the overlap between business and personal finances is tricky. The budget template provided in this article only refers to personal finances. Business finances are best addressed with a CPA who specializes in tax.
WHERE TO GO FROM HERE
I hope you find this article useful as you revisit your cash flow situation on the brink of a potential recession. It is difficult to illustrate every plausible scenario within the confines of one article.
Let us know if you are looking for a more customized cash flow to adapt to your family’s changing circumstances.
At WorthyNest®, we guide parents through important financial decisions using a values-based approach. Contact us to explore a one-on-one relationship.