Recessions are part and parcel of the economic cycle. There are phases when economic activity is down. Consequently, unemployment may increase; incomes may stagnate, and inflation may rise. In recessions, we see lower purchasing power and living standards, and achieving financial goals becomes tougher.
Financial well-being is an important goal for most families and can be accomplished to a large extent by wealth creation. It enables the sustenance of a desired standard of living, and accomplishment of goals at various life stages. However, events like recessions which upset the economy can impede the achievement of financial stability.
While recessions may be inevitable, their impact on your finances can be controlled. Here are four strategies to help you recession-proof your finances.
Save a third of your monthly income
Commit to set aside one-third of your monthly income towards your savings. Manage your monthly expenses with the remaining amount. While it may be challenging and require you to re-assess your routine spends, it is one of the most effective ways to build a corpus. As your income rises, increase the proportion you set aside for savings, which can then be invested for wealth creation.
Build an emergency fund
An emergency fund can significantly help cushion the impact of financial instability brought on by recession. Set aside a fourth of your savings to build your emergency fund which should ideally be worth 12x your monthly income. If you must dip into this fund to meet a contingency, ensure that you replenish it.
Invest using an asset allocation strategy
Wealth creation is essential for building financial stability and should be started as early as possible. Investing your savings based on a strategy suited to your financial goals is a good starting point.
For instance, those aged under 40 years may benefit from a portfolio with sizeable exposure (up to 70%-80%) to equity-oriented instruments, while investing the remaining (20%-30%) in debt instruments or gold. While investing in gold may be an ideal avenue to shield against inflation, care must be taken keep your exposure to 10% or under.
In another example, investors aged between 40 and 60 years may aim for a portfolio with low to moderate equity (30%-60%) exposure, based on their risk appetite. To achieve this, they may consider investing in equity-oriented SIPs mainly comprising diversified equity funds and balanced-advantage schemes. The balance may be invested in debt-oriented instruments like debt funds, fixed deposits, and postal deposits. 10% exposure to gold should be retained and can be done via Sovereign Gold Bonds (SGBs), Gold ETFs, and Gold Funds.
Get adequately insured
Uncertainties are an inevitable part of life. Being prepared for them can significantly reduce the stress they cause. Having adequate insurance coverage – life and health, is an excellent safety net for you and your family in times of financial turmoil.
Health insurance can help you save considerably on medical expenses, while keeping your long-term investments intact. For individual coverage, having a policy worth 50% of your annual income is advised. For group health plans, the amount of adequate coverage will depend on various factors such as your family’s needs, city of residence, hospitalisation expenses, etc.
The importance of having adequate life insurance coverage cannot be emphasised enough and makes all the difference to a bereaved family. The rule of thumb here with regards to life insurance is to have coverage worth 20 times your annual income. For instance, if you earn Rs 5 lakh annually, your insurance cover must not be below Rs 1 crore.
Let’s understand all these strategies in action with an example. A 25-year old individual drawing a monthly salary of Rs.40,000 will be able to build an emergency corpus worth Rs.17.25 lakh (ROI of 5% from liquid funds) by the time they turn 40. This projection is based on the assumption of their income rising by 10% each year, with proportionate increases in their investments. Considering 12% annual returns, their investments would be valued at Rs.83 lakh. In case of a recession that leads to a job loss and a 50% drop in investment value, the accumulated emergency fund will help the individual meet their expenses for the next 12 months.
Implementation of any financial strategy relies heavily on discipline. You can maintain financial discipline by being consistent with your investments, cutting back on unnecessary spends, repaying your dues in time and tracking your credit score regularly. After all, it is the little drops that make the mighty ocean.
(The author is CEO, Bankbazaar.com)