With all the unpredictability around the world right now, economic downturns left, right and centre; the word on the lips of many a person is “recession”.
Only yesterday there were headlines about Australia heading for their first recession in 30 years!
But what does it all mean?
What is a recession?
The term “recession” has become somewhat of a buzzword in recent years and the crash of 2008 made recessions kind of famous to a new generation.
A lot of the time, the word “recession” is thrown around with the aim of immediately instilling a sense of doom and gloom.
Let’s quickly review the actual definition of a recession:
A recession is two consecutive quarters of negative economic growth.
Not so scary right?
Recessions and redundancies
The worst type of R&R.
The reason that a recession can equal bad times at the Kwik-E-Mart is because of the interconnectivity of our economic systems. Negative growth in the economy is essentially a shrinking. When this happens, the reduction in economic activity often leads to cutting costs wherever possible.
This cost cutting is most significantly felt when it results in redundancies or fewer job opportunities being available. The job market becomes less fluid during these periods.
Picture a marketing department for a fruit company. They normally operate with a certain sized budget. That budget is reduced due to lower economic activity and less money circulating within the business.
One of the quickest and biggest costs to get rid of is personnel. This is usually in the form of redundancies. It’s often much easier and simpler for a business to reduce their number of employees than it is to liquidate (sell) their assets or downgrade the equipment being used, which can prevent their ability to operate, make money and grow again.
So the marketing department of this fruit company is now leaner, has less staff, and lower overheads. Remaining employees at the fruit company are sometimes left working harder, picking up the slack and often do so willingly because they’re just grateful to still have a job!
A downturn in business will often mean that the redundancies are justified because there is simply less work to do.
How often will a recession occur?
This is always a popular question asked, and unfortunately the answer is very difficult to predict with any amount of accuracy. For every one person that has managed to guess when a recession will take place, there are hundreds and thousands who have guessed incorrectly.
What is certain, is that it’s not a case of IF a recession will happen but WHEN.
Armed with the knowledge that a recession and slowdown of economic growth is just part of the natural cyclical nature of our economies, should allow you to approach them in a level-headed manner. Understandably this is hard to do if you’ve just lost your job, have a mortgage to pay and a family to feed. But try and remember that it’s likely a boom will follow on after a recession.
Unfortunately recessions will happen and jobs will be lost. Whole departments of companies and businesses in their entirety will disappear into thin air as if they never existed at all. This doesn’t mean that you must remain an eternal pessimist and just sit around waiting for the next downturn.
Simply being aware that these economic events will happen at least a few times throughout your life will allow you to make better financial decisions when the going is good, leaving you more prepared for when things might get a bit ugly.
Opportunities in a recession
If you’re a glass half-full kind of person, a recession can actually provide some pretty unique and amazing opportunities.
Like I mentioned, redundancies can be one of the biggest negative factors during a recession. On a personal level, if you’re made redundant and receive a severance package, it really opens up a lot of options for you.
Have you ever wanted to travel the world but not been able because of work?
Or what about spending some more quality time at home with your family? Perhaps working so much has meant you’ve not had this option in the past.
Were you simply treading water in your last job but just never had the time or the energy to look for something better?
Have you always dreamed about starting your own business but have always been too scared of leaving your “secure” job?
Do you wish that you had some quality time in order to find out what your passions are and be more creative?
There are a tonne of possibilities that you can explore if you find yourself being made redundant during a recession. The other benefit is that recessions are felt pretty much across the board and when things pick up again, no one is going to look down on you or question your ability simply because you were made redundant during a recession. Being laid-off in an economic downturn does not reflect badly on you personally, your job is simply just a casualty of the greater economic battles.One thing that I also want to make clear, is that being able to make the most of these kind of opportunities relies on some foresight and planning on your part. If you’re made redundant and still have a lot of overheads, I wouldn’t blame you for going to panic stations or desperately applying for jobs that will at least make sure the bills are paid. To avoid this desperate clamouring it is absolutely VITAL that when you are working and times are good, you build up an emergency fund.
Every person’s emergency fund will be different, but the most important thing is that you have one. Calculate 3-12 months’ worth of your most important expenses, save like crazy until you reach that figure and then set it aside in an easily accessible account. This money can be used from time to time for actual emergencies but where it will really prove its importance is during a real worst-case scenario.
Imagine how much less stressful would it be to lose your job during a recession knowing that you’ve got that emergency fund. A fund that will act as a cushion to give you a certain degree of freedom and opportunity without sacrificing your quality of life.
Investing during a recession
Although many people panic during an economic downturn, those with level heads can actually profit.
Our economies are in a constant state of flux. The very nature of how our economy works means that there is a “boom” element and a “bust” element.
When economic activity is growing, this is the boom. Unfortunately, economic growth also means building a certain level of pressure and eventually there needs to be a release for that built-up pressure. This relieving of economic pressure is the bust.
Instead of viewing an economic bust and a recession as a doomsday event, we need to simply view it as a natural part of the economy. The release of this pressure and contraction of the economy is what allows healthy long-term economic growth. Generally the longer a period of growth, the greater the crash.
If you imagine the economy as a car, economic growth is like the car accelerating. Then at some point, the car must slow down, this is a recession. The term “crash” is wrong because the economy does not come to a standstill or explode, it just slows down. A slower rate of growth does not mean the end of the world or that the car has stopped altogether, the car is simply having a breather before the next period of acceleration.
During these times when the economy slows down and shrinks, it often means that the value of companies fall and therefore so does their share price. As the share prices fall, people panic and think they’d better sell before they “lose” even more money. When in actual fact, it is only when you sell shares at a lower price that you’ve realised a loss. Holding on to shares whilst the price goes down does not actually equate to a loss.
These falling prices of companies actually provide a great buying opportunity, it’s like a sale. Shares that would have cost you $100, may now only cost $75 or even $50! Investing is a weird psychological battle that seems to go against our herd mentality instincts. If anything else was discounted at 25% or 50%, we clamour in shops to take advantage of the deal. When ownership in a company costs less, we are much more hesitant, even though the intrinsic value of that company hasn’t altered much, just our attitude towards them.
Just because the court of public opinion is less optimistic about a company and the share price falls, does that really impact how much that business is worth?
Preparing for an economic downturn and a recession does not mean constantly living in fear.
It’s just important to remember that the good times will not be everlasting and neither will the bad times.
Be sensible and prepare yourself both mentally and economically so that when everyone else is flapping around feeling sorry for themselves, you can ride things out and even come out stronger on the other side of a recession.