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Are We Headed for a Recession and How Much Will It Sting? Your Questions, Answered

Crumbled US dollar bill on orange background
James Martin/CNET

This story is part of So Money (subscribe here), an online community dedicated to financial empowerment and advice, led by CNET Editor at Large and So Money podcast host Farnoosh Torabi.

What's happening

A rising number of financial experts say the US is headed into a recession, which is defined as two sequential quarters with a significant, pervasive decline in economic activity.

Why it matters

Recessions are historically marked by widespread layoffs, bankruptcies, higher borrowing costs and turbulence in the stock market.

What's next

Gather facts to protect your financial position. No one can predict the future, and it's important to move calmly and deliberately.

As inflation continues to soar, economists and financial experts worry we could be on the verge of a recession. But the Federal Reserve is more concerned about the longevity of inflation this time around, and the danger of elevated prices becoming the new normal. 

"The risk is that because of a multiplicity of shocks, you start to transition to a higher-inflation regime," Federal Reserve Chairman Jerome Powell said at a European Central Bank forum on Wednesday. "Our job is literally to prevent that from happening. And we will prevent that from happening."

To lower inflation, historically, the Fed raises the federal funds rate. But this year's three rate hikes -- including the most recent, which was the largest in nearly three decades -- haven't made a dent in inflation, which currently sits at 8.6%, more than four times higher than "normal" inflation.

As for the possibility that the central bank's aggressive efforts to slow down the economy could cause a severe economic downturn, Powell acknowledged the risk. But he also noted, "I wouldn't agree that it's the biggest risk to the economy. The bigger mistake to make ... would be to fail to restore price stability."

Technically, the country is in a recession when gross domestic product, the value of all goods and services produced during a specific period, falls during two quarters back-to-back. In the first three months of 2022, the US GDP dropped by 1.4%. The National Bureau of Economic Research, which makes the official call about a recession, meets in July. 

With recession fears ramping up, you're probably concerned about what this could mean for your finances and your employment. My So Money podcast audience recently sent in a number of questions related to recessions about how best to prepare, save, invest and make smart money moves in these uncertain times. Here's a bit of guidance to help navigate this difficult financial period.

First, what could I see in a recession?

It's always helpful to go back and review recession outcomes so that we can manage our expectations. While every recession varies in terms of length, severity and consequences, we tend to see more layoffs and an uptick in unemployment during economic downturns. Accessing the market for credit may also become harder and banks could be slower to lend, because they're worried about default rates.

Read moreThe Economy Is Scary. Here's What History Tells Us 

If the Federal Reserve continues to raise rates to clamp down on inflation, we'll see an increase in borrowing costs -- for mortgages, car loans and business loans, for example. So, even if you qualify for a loan or credit card, the interest rate will be higher than it was in the prior year. We're already seeing this in the housing market, where the average rate on a 30-year fixed mortgage is nearly 6%, the highest level since 2009.

The only bright spot in some recessions is that, as rates go up and inflation cools, prices on goods and services fall and our personal savings rates could increase, depending on the labor market and wages. We may also see an uptick in entrepreneurship, as we saw in 2009 with the Great Recession, as the newly unemployed often seek ways to turn a small business idea into reality.

Should I stop investing in my 401(k)?

With stocks in a downward spiral for weeks, many want to know how a recession could impact their long-term investments. Should you stop investing? The short answer is no. At least, not if you can help it. Avoid panicking and cashing out just because you can't stomach the volatility or watch the down arrows. 

My advice is to avoid making knee-jerk reactions. This may be a good time to review your investments to be sure that you're well-diversified. If you suddenly experience a change in your appetite for risk for whatever reason, talk it through with a financial expert to determine if your portfolio needs adjusting. Some online robo-advisor platforms offer client services and can provide guidance. 

Historically, it pays to stick with the market. Investors who cashed out their 401(k)s in the Great Recession missed out on a rebound. Despite the recent downtick, the S&P 500 has risen nearly 150% since its lows of 2009, adjusted for inflation.

The one caveat is if you desperately need the money you have in the stock market to pay for an emergency expense like a medical bill, and there's no other way to afford it. In that case, you may want to look into 401(k) loan options. If you decide to borrow against your retirement account, commit to paying it back as soon as possible.

Should I wait to buy a home?

With mortgage rates on the rise and housing prices not cooling nearly fast enough, owning could be more expensive than renting right now. A report from the John Burns Real Estate Consulting firm looked at the cost to own versus renting across the US in April and found that owning costs $839 a month more than renting. That's nearly $200 greater than at any point since the year 2000.

Fixed rates on 30-year mortgages have practically doubled since last spring, which has helped slow down offers and cool housing prices -- but competition among buyers is still stiff due to historically low inventory. All-cash offers and bidding wars continue in plenty of markets.

If you've been shopping for a home in recent months or the past year to no avail, you may feel exhausted and defeated.

As I stated in my newsletter: Don't be hard on yourself. You're not doing anything wrong if you have yet to offer the top bid. While it's true that a fixed-rate mortgage can offer you more predictability and budget stability, as long as inflation continues to outpace wages, there are bright sides to renting right now. For one, you're not buying a home in a bubble market that some economists are saying is soon to burst. If you have to unload the home in a year or two -- during a possible recession -- you may risk selling at a loss.

Secondly, renting allows you to hold onto the cash you would have spent on a down payment and closing costs, and will help you stay more liquid during a time of great uncertainty. This allows you to pivot more quickly and secure your finances in a downturn. Remember: Cash is power.

Should I expect layoffs?

With the unemployment rate sitting at 3.8%, the job market may appear to be the one, and possibly only, stable part of the economy at the moment. But that's likely to be temporary, as companies battling with the current financial headwinds -- including inflation, rising interest rates and weakening consumer demand -- have already begun to announce layoffs.

In the Great Recession, unemployment reached 10%, and it took an average of eight to nine months for those out of work to secure a new job. So now could be the time to review your emergency fund if you think there's a shortfall. If you won't be able to cover a minimum of six to nine months' worth of expenses, see if you can accelerate savings by cutting back on spending or generating extra money. It's also a good time to make sure your resume is up to date and to establish contact with influential individuals in your professional and personal network. 

If you're self-employed and worried about a possible downturn in your industry or a loss of clients, explore new revenue streams. Aim to bulk your cash reserves as well. Again, if previous recessions taught us anything, it's that having cash unlocks choices and leads to more control in a challenging time.

Should I expect the interest rates on my debt or loan to go up?

As the Federal Reserve continues to raise interest rates to curb inflation, adjustable interest rates may increase -- ratcheting up the APRs of credit cards and loans, and making monthly payments more expensive. Reach out to your lenders and card issuers to learn about low-interest credit options. See if you can refinance or consolidate debts to a single fixed-rate loan.

In past recessions, some financial institutions were hesitant to lend as often as they did in "normal" times. This can be troubling if your business relies on credit to expand, or if you need a mortgage to buy a house. It's time to pay close attention to your credit score, which is a huge factor in a bank's decision. The higher your score, the better your chances of qualifying and getting the best rates. 

My final note is that it's important to remember that recessions are a normal part of the economic cycle. Long-term financial plans will always experience some declining periods. Since World War II, the US has had about a dozen recessions and they typically end after a year or sooner. By contrast (and to give you some better news), periods of expansion and growth are more frequent and longer lasting. 

Read more8 Ways to Recession-Proof Your Finances