Two US banks failed last week and with high interest rates analysts and economists across the world are expecting a recession soon.
Today we are going to talk about what's a recession, why we are expecting a recession, and more importantly, how you can prepare for a recession.
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What is a recession?
A recession is technically described as two quarters of negative economic output. So, if the GDP of your economy has been declining for the last two quarters, that means that you are in a recession. Now, what I really want to emphasize though, is that there's a lot of media attention and hype around recessions.
However, recessions are a really usual part of an economic cycle. What I really want to encourage you to think about is that recessions are normal. You will very likely have already seen one and you will very likely see another one. So, this fear mongering around recessions is absolutely not useful. I would rather that you be prepared for a recession.
Now, with that said, why are we even talking about recessions. There are a few reasons why economists and analysts are expecting a recession.
The first reason we are expecting a recession is because of high interest rates across the world and central banks across the world had to raise interest rates because of a very high inflation, driven by a few factors, including the war in Ukraine, and also increased money supply across the world during the pandemic and, 40% of the money supply in the US was printed during the pandemic, which is what led to a lot of inflation, and therefore we now need to raise the interest rates to bring down the inflation.
But what does an increased interest rate have to do with a recession?
Now, when the interest rates are high, the opportunity cost for the money is also high. In simple terms, this means that if you get a high interest rate just by putting your money into the bank, you would think twice about investing in a risky startup. And, when you don't invest in startups and businesses, the economic output produced by those startups and businesses go down and this could lead to a lower economic output and lead to a recession.
Additionally, over the last week, two US banks failed.
The first one was Silver Gate, which was related to a crypto crash.
FTX going down had implications on the exchanges and that ultimately caused a bank run on Silver Gate Bank, which is why they crashed on Wednesday. I won't go into too much detail about that, but Patrick Boyle has done a wonderful video about all of this.
But more interestingly for me, Silicon Valley Bank failed.
Silicon Valley Bank is the 16th largest bank in the US, so this is a big bank. And Silicon Valley Bank had customers who are in the Silicon Valley region, therefore, a lot of venture capitalists and tech startups.
What this means is that a lot of tech startups might be starved of cash and their deposits were protected only to $250k if they were protected, and most of the tech startups would very likely have millions, sitting around in that bank.
Just to give you an idea of how big the scale is at the time of failure, Silicon Valley Bank had $175 billion in deposits and $209 billion in assets.
We also don't know yet how much exposure the other banks in the ecosystem had to these couple of banks. So, this could mean that a lot of other systemic failures happen and also tech layoffs become more prominent.
So, now you know, why we are expecting a recession, but what is more important and within your personal power is how you respond to the situation and prepare for the situation.
So let's talk about how you can prepare for a recession.
The first one is to build your emergency fund.
An emergency fund is typically three to six months of living expenses put aside in a liquid easy access account. This does not need to be equal to your salary. So from your salary, strip out your investments and luxurious expenses and only put aside the money that you use to just get by for three to six months without going bankrupt. So, if you don't have an emergency fund already, start building an emergency fund now.
The next one I have for you is to use discretion around financial investments.
Now with the markets going down with crypto crashing, with real estate crashing, a lot of alternative investment arrangements might come up your way, including investing in alcohol or investing in art. But do you really know a lot about alcohol or art or whatever other investment opportunity presents itself? If it sounds too good to be true, it probably is not true. So, use your discretion.
The third point invest only in regulated products.
Because if it's regulated, then the regulator is also responsible for maintaining law and order around that investment product. If you are investing in art or wine and they were to go bankrupt, your regulator will have very little power to protect you in that scenario.
The next one is Diversify your Money.
Of course, you want to diversify your investments so that you don't have a concentration risk on, say for example, only the tech sector or only the oil and energy sector, or only another consumer sector. You want to diversify your portfolio across a different set of investment types.
But what I would also encourage in case a recession is coming is to diversify the liquid money that you hold into different bank accounts. In the US, they cover $250k and in the UK they cover up to £85k of deposits sitting in a regulated financial institution. But if you were holding that cash-in, liquid assets for a mortgage you want to diversify the money into chunks under these limits.
So say you are in the UK and you have £200K to your name, I would put £85K in bank one, £85K in bank two, and the rest in bank three. I understand that it's a bit of an admin challenge, but hopefully, this will keep you safer than if one bank was to go down and then you end up with a financial nightmare.
The next one is to diversify your income.
If you have only one or two sources of income, which are your day job and the investment in the market, I would encourage you to consider a third and a fourth way of getting money through the door should you end up in a situation where you have a job loss or your investment portfolio goes down.
A few quick ways to do that are freelance on Upwork or Fiverr, pick up some tutoring, and so on.
And the next one is to upskill yourself.
Most of the jobs that will become redundant in the next few years will be jobs that are being automated. And if you think your job has the potential for automation, lean into the technology and bring the technology in so that you can be the person responsible for transforming your company or your business unit with that skill.
So while thinking of upskilling, there are a couple of things to consider---
1. If it's in demand in the market.
2. If you really enjoy it.
3. If you are playing to your strengths.
There's no use in you starting to learn how to code if you really terribly hate it.
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