It’s Better to Be Overprepared for a Recession Than Underprepared

To put it lightly, the first half of 2022 has been a challenging year in the stock market. Between the major indexes being down double-digit percentages year to date, blue-chip companies seeing their stocks plunge, and portfolios losing value seemingly by the hour, it’s been rough. Add in rising inflation at a level that we haven’t seen in decades, and it has many people wondering if a recession is on the way.

I can’t say with 100% certainty whether we’re headed for a recession, but I can say that it’s always better to be overprepared than underprepared for one. If you stay ready, you won’t have to get ready.

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Prioritize an emergency fund

Before investing, your first priority should be establishing an emergency fund. You never know when your car may need repairs so you can get to work, something important in your house breaks, or you’re suddenly jobless. It’s nice to have investments, but you don’t want to find yourself in a situation where an emergency pops up, and you have to sell some of your stocks to cover the cost.

Having to sell stocks unexpectedly can hurt you both in the present and future. It can spark a tax bill now that could add to whatever costs you’re trying to cover. If you sell stocks for a profit, you must pay capital gains taxes. And any shares sold now are also shares that don’t have the chance to continue growing in the future.

To determine how much you need for an emergency fund, first add up all your monthly expenses. If you’re single and the only person’s livelihood you have to look after is yours, you can likely manage with three months of expenses. If you have a family and are responsible for other people, you should aim to have at least six months’ worth of expenses saved.

Pay down your expensive debt

Unfortunately, nothing in stock investing is guaranteed. You know what is guaranteed? The debt you owe, along with the interest that comes with it. If you have debt (particularly with high interest), prioritize cutting it down over investing — especially with a potential recession looming. Making money off stocks can be counterproductive if you pay more in debt interest than you’re earning. It’s even worse if you lose money investing while your debt is simultaneously piling up.

And not all debt is created equal; some kinds are way costlier than others. Your credit card debt, for example, is likely to have a higher interest than your student loans. While some people like eliminating debts with the lowest balance first, you will save yourself money in the long run by eliminating your highest interest debt first.

Focus on larger-cap companies

Large-cap companies have a market capitalization of $10 billion or more. These stocks may not have the hypergrowth potential of small-cap stocks, but because of their size and financial resources, they tend to be more stable investments than smaller companies that are more sensitive to economic conditions. While nothing is guaranteed, large-cap companies are generally in a better position to weather bad economic storms.

To spread out risk, it would help to invest in a large-cap index fund. The S&P 500 — which is often used to gauge the state of the overall market — has produced solid returns after every correction, bear market, and recession that’s happened since its inception in 1957, and there’s no reason to think it won’t continue to do so going forward. During times of uncertainty, large-cap companies can provide a bit of stability.

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Stefon Walters has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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