5 listopada, 2022

Recessions make us do dumb things with our money. Here’s how to keep a cool head and avoid the bear traps.

The recession warning bell is sounding loudly, which means it’s time to have a long, hard look at your financial situation — while keeping a cool head.

We do weird things in times of recession, like comfort-eating meatloaf and ice cream, according to food trend experts. We’re also more prone to panicking and making mistakes with our money, personal finance experts and economists told Insider.

Professor Dan Ariely, a behavioral economist at Duke University, said people have a herd mentality during a downturn, employing a „scarcity mindset” that makes them think things are worse than they really are.

„When things are uncertain, people have a very hard time thinking correctly,” Ariely said. „Recessions are all about uncertainty and fear.”

The fear factor

Bloomberg economists said recently they see a 100% chance of a recession in 2023. Goldman Sachs CEO David Soloman said in late October that the US economy was facing a „prolonged downturn.”

Recession, or fear of recession, triggers feelings of financial hopelessness, experts said. These feelings can be influenced by bad news about the broader economy. Downturns are often preceded by stock market falls, which weigh on investors’ minds — indeed, the S&P 500 has lost a fifth of its value this year.

Ramit Sethi, founder of I Will Teach You To Be Rich, an educational site for investing and managing finances, said his clients are often influenced more by news about the wider economy than what’s happening with their own finances.

„People look at headlines in the news, they look at what their friends are talking about, and that creates their view of the world,” he said. „That’s why I’m now getting more questions than ever about inflation.”

Sethi advises people to focus on their long-term financial plans rather than negative headlines.

Chad Rixse, director of financial planning at Forefront Wealth Partners, said people can be emotionally affected by significant falls in their wealth and act irrationally to protect what remains — even though stock markets, and the economy, are cyclical.

„When people see their portfolios are down 20% on the year, they start to have an emotional reaction to that,” he said. „It’s hard to keep the big picture under perspective.” 

With so many dueling thoughts and inadvertent irrationality, it can be challenging to understand how to calmly navigate a recession without damaging your finances.

„When things are uncertain on the outside world you want to give people a sense of control,” Ariely said. „Dealing with money well requires a lot of goodwill and a lot of self-control. For that people need motivation.”

He added: „If we want people to respond well to the recession they need to feel empowered to make good decisions. And if people feel out of control, it won’t just have an economic impact, but a big psychological impact as well.”

Keep a cool head

Jeremy Schneider, founder of financial coaching site Personal Finance Club, said for most people, preparing for a recession is like preparing for a hurricane.

„Do the same things during bad financial times that you do during good financial times, which is live below your means, set up a good financial framework by paying off your non-mortgage debt, save an emergency fund of three to six months'” worth of expenses, he said.

„Maybe if you think your job might be impacted by the recession, you could put that in a higher end — like six months plus – and then invest early and often. And invest before, during, and after the recession because markets do volatile market things.”

If you aren’t confident about your finances, it’s time to start working towards building up an emergency fund through new saving and spending habits, experts advise. These are good habits regardless of the state of the economy.

Nikolai Roussanov, professor of finance at The Wharton School of the University of Pennsylvania, said the biggest mistake is failing to save before a downturn strikes. „A recession sort of reveals problems that people may have, and not necessarily pay attention to much in the good times,” he said. In good times, with interest rates low, your viewpoint can be obscured by the ease of getting credit, he said.

Stick with the plan

Sethi says effective recession planning is like good parenting. „A confident parent has confidence through competence,” he said. „They have learned, they’ve practiced, they ask other people they trust for advice and then they stick with the plan. That’s the same thing with money.”

When building an emergency fund, experts advise against cashing in investments from index funds and other sources to supply it.

Roussanov said investors are often susceptible to pulling investments out following market declines and get back in too late to benefit from the recovery. Rixse encourages dollar-cost averaging during a recession to smooth out the cost of investing.

Emilie Bellet, founder of Vestpod, a website that aims to empower women’s finances, says it helps to be philosophical about your money and the reason you’re spending it. 

„Think about what money really means to you, what your values are, as well as your future goals,” she said. „Don’t strive to have what others have, and be true to yourself. It’s easy to get caught up in comparing yourself to others.”

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