Economic downturns may have upsides for the opportunistic.
- Evaluate your emergency fund and cash flow constraints.
- Take advantage of favorable conditions by refinancing debt.
- Lower future taxes by making a Roth conversion.
There’s no denying it — tough economic times are likely coming. Market indicators are pointing to an economic downturn, including grim predictions of falling markets. How can you take advantage of a recession? Read on to find out.
1. Be on the defensive
While recessions come with opportunities, such as depressed markets and low interest rates, they also come with financial threats including layoffs and decreasing nest eggs. Ahead of a possible recession, your top priority should be to shore up your financial plan.
An adequate emergency fund acts as a cushion in case of job loss or other unexpected financial need. Experts recommend that Americans keep between three and six months of expenses in cash savings. However, just as important as funding your emergency fund is knowing when to use it. Balancing withdrawals is another important component of emergency fund utilization, and as a general rule, only non-discretionary expenses should be covered by the emergency fund.
The most painful part of losing a job can be losing a primary source of income. One way to balance your cash flow is to look at cutting expenses to match the temporary lost income. Consider creating a budget that categorizes spending into two categories: discretionary and non-discretionary. Discretionary expenses, also called wants, are expenses that are not necessary to daily living. Non-discretionary expenses are needs that are central to your living expenses. Think of mortgage payments, insurance premiums, and gas expenses as non-discretionary expenses, which are vital to maintaining your standard of living. Using a budgeting app can also help.
2. Refinance debt
When markets fall, often so do rates on mortgage loans. And for homeowners who can afford to spend time and money refinancing, a recession may be an opportunistic time to do so.
In early 2021, following the market drop from the COVID-19 pandemic, mortgage rates fell to a nearly 50-year low. For those who timed it right, locking down a rate in the mid-2% range became possible. Mortgage rates fell so drastically in 2021 because of low rates of inflation and emergency action by the Federal Reserve. It should be noted, however, that the high interest rate environment of today is significantly different from the low interest rate market downturn in early 2021. We may enter a period of high inflation and low economic growth, also known as stagflation, in which case this strategy may not be on the table.
So should you refinance your home? It depends on your current rate and the rates offered at the time you consider the move. Generally, if the new rate is 1 percentage point or more lower than your current rate, and you plan to live in the home for a long period of time, it makes sense to refinance. Refinancing is a long and difficult process, so be sure to know what you’re getting yourself into before biting the bullet.
3. Roth conversion
Roth conversions are a way for many Americans to swap their traditional tax-advantaged accounts for Roth accounts by prepaying tax. But when does it make sense to do so?
Because Roth conversions involve tacking on additional taxable income, strategy is key to paying the least on your Roth conversion. Portfolio assets are reduced during market downturns, making it an advantageous time to initiate a Roth conversion. By converting assets that are depressed, fewer tax dollars are recognized as having been converted, yielding lower taxes while still achieving the desired effect of after-tax growth. Always consult with your tax advisor before initiating a Roth conversion.
Drops in rates and markets can represent unique opportunities — if you have a strategy in place to take advantage of them. Roth conversions and mortgage refinancing are two opportunities to do just that and win in a recession.
Alert: highest cash back card we’ve seen now has 0% intro APR until 2023
If you’re using the wrong credit or debit card, it could be costing you serious money. Our expert loves this top pick, which features a 0% intro APR until 2023, an insane cash back rate of up to 5%, and all somehow for no annual fee.
In fact, this card is so good that our expert even uses it personally. Click here to read our full review for free and apply in just 2 minutes.
Read our free review