As the COVID-19 outbreak continues to batter markets and force more businesses to close their doors, talk of a looming recession grows louder. There is no question that many more jobs are at risk, and for those whose livelihoods are particularly vulnerable, now is the time to take stock of your finances to determine just how well prepared you are for a potential recession.
Recession-Proofing Your Finances
When it comes to the government’s ability to weather an economic downturn, Finance Minister Bill Morneau likes to talk about Canada’s “fiscal firepower.” Unlike the government, as a private citizen you can’t just borrow or raise taxes when you need extra money. That’s why many financial experts recommend keeping an emergency fund at hand sufficient to cover your expenses for at least three months.
If you’ve had limited success in the past building your savings, we’ll look at ways you can catch up and get your savings back on track. We’ll also identify potential areas where you can reduce your spending to help further prepare you for a possible economic slump.
Creating a Budget
In order to get a true picture of your spending, create a budget that lists all your monthly payments. The Financial Consumer Agency of Canada has a helpful online budgeting tool that you can use to create your personalized budget.
List Your Expenses
To get started with your budget, look at your bank statements and list all your expenditures for each month. Next, categorize each one as “necessary” or “nice to have.” Necessary expenditures include your food and housing costs, while things such as internet subscriptions and entertainment spending should be listed in the nice to have column.
One additional category to consider is debt-related spending. This section is where you should record spending on credit card payments and any other personal loans.
Assess Your Spending
Now that you’ve categorized your total spending for each month, it’s time to look for areas where you can potentially reduce your monthly costs. Generally, there’s not much opportunity to find savings in your necessary expenditures, so concentrate on your non-essential spending since this is discretionary.
If it’s been a while since you looked closely at your spending, you might be surprised at how those little things you routinely purchase add up over a month. Cutting back on these things and putting that money instead into a dedicated savings account will help you build your savings.
Consolidate and Prioritize Debt
Even though talk of a recession may be looming, you still have to repay your outstanding debt. However, you may be able to reduce how much you spend each month by consolidating higher-interest debt into a single loan at a lower interest rate.
For example, many credit cards typically charge a higher interest rate than other types of loans. A low balance transfer credit card allows you to transfer the balance you owe on your high-interest credit cards to a credit card with a lower interest rate.
Another approach to lowering how much you spend each month is to prioritize liabilities, so you’re paying down your most expensive debt first. Two common approaches to pay down your debt is to use either the “snowball” method or the “avalanche” method. Both involve creating a repayment plan that targets specific debts.
Borrowing from Yourself
For homeowners, borrowing against the equity in your home is one possible route to help you weather a prolonged downturn if you don’t have sufficient savings at hand. A Home Equity Line of Credit, or HELOC, offers a more flexible repayment schedule and a lower rate of interest than most personal loans.
A HELOC also gives you another option if your savings are held in a Registered Retirement Savings Plan (RRSP). Because the markets have suffered deep losses in the wake of the COVID-19 outbreak, selling investments in your RRSP to free up some extra cash means you will likely be selling at a significant loss. You will also have to include money you withdraw from your RRSP as income for the year and pay additional income tax.
It may seem a long way off just now, but the impact of this outbreak will subside, and the economy will recover. Collapsing your RRSP now prevents you from benefitting from a potential rebound once we get through this crisis.