Your Budget in a Recession

September 26, 2019  | By Kevin Smith

As of September 2019, life is good here in Austin, TX and much of the United States. Wages are up, jobs creation is abundant, the business community is thriving, home values have been on the rise for years. People under 30 have either a faint recollection or no memory of a recession. Life isn’t grand for everyone, of course, but we have a tendency to accept the current conditions as the new normal, projecting the same trajectory forever into the future. But history strongly suggests otherwise. There WILL be another recession. Nobody knows when our how bad it will be, but it serves us well to consider how our lives might change if it happens soon.

I count myself among those who have become complacent budgeters, and I should know better. Let’s come to terms with the grimmer side of reality: stock prices fall, income is at risk, inflation can rise dramatically, and lenders will demand to be paid. We have all heard that an outrageous percentage of Americans are one medical crisis away from bankruptcy. That is probably true. Recessions bring another type of crisis: job loss. The effects can be catastrophic. Let’s examine what happens to an affluent family during a layoff.

• Married couple with two young kids
• Location: Austin, TX
• Household income: $350k to $400k
• Home value: $700k
• Cash: $25k
• Investments: 401k and 529 college funds
• Living ‘the good life’

Here is the situation. Sally has a great job in sales for a well known tech company. The recession hits, the sales team gets cut in half and Sally loses her job. Bob works for the State of Texas, so his job is relatively safe. They immediately cut back on discretionary spending to tighten the budget, hoping the market will quickly bounce back and Sally will find a similar job soon. A year goes by and the end is not in sight. There seem to be hundreds of applicants for every job. Sally picks up some consulting gigs and drives for Uber in between. As their emergency fund dries up, they take more extreme measures, but can’t stop the bleeding. Take a look at the numbers…

What can they do?

1. Reduce debt. Sell the cars? The car loans are new, so they are upside down and they would have to write a check to the lender.
2. Take the kids out of daycare and after school care. They could, but then Sally would not be able to earn as much and keep her job search alive.
3. Downsize the house. They just refinanced and pulled out cash for a remodel, so there isn’t much equity. On top of that, the housing market dried up and prices are falling.

This is an affluent family and the situation is grim. Imagine the impact on families with fewer resources. The purpose of the illustration is to encourage designing a financial plan with enough flexibility to absorb a recession while maintaining an enjoyable lifestyle. This becomes harder to do the longer we go since our last recession. Here are a few concepts that would have helped the family in this example.

• Keep debt obligations to a level that could be handled with a decline of income of 25% or more. This means resisting the temptation to buy the most expensive houses and cars that the banks will allow.
• Have an emergency fund that covers enough time to find a new job after a layoff. The amount should be higher for more volatile job positions.
• Remember that maintenance costs scale with the value of cars and homes, and these costs don’t go away in a recession.
• Remember that it is VERY difficult to take a step backward in ‘quality of life’ expenses like dining out, home services, Amazon spending habits, and travel. Taking one step back may be manageable in a recession, but taking two steps back will be painful.

– Kevin X. Smith, CFA