A recession can be defined as a slowdown in overall economic activity. As 2012 draws to a close, economists are somewhat fearful that factors such as the fiscal cliff could reverse the slow economic recovery in the U.S. from what has been coined as the "Great Recession." But how could this impact your net worth? There are several ways that a major recession can reduce your bottom line.
This is the most obvious way that a recession could impact your net worth. Recessions always bring unemployment, which increases the risk that you could get laid off. A recent survey by the Fed showed that unemployment in America nearly doubled from 5% to 9.5% from 2007 to 2010. This would in turn force you to live off of your savings or else live off of your credit cards or get a personal loan to tide you over until you find another job and thus reduce your assets (or increase your debt).
You may be lucky enough to keep your job - as long as you're willing to take a cut in pay. Sentier Research released a report showing that average household income as of April of 2012 was still more than 8% below what it was at the end of 2007.
Decrease in Property Values
The housing industry is always hit hard in a recession, because fewer people are working, which reduces the pool of available homebuyers. Since 2008, property values have declined by an average of nearly a whopping 40% across the board. The major decline in the net worth of the average American family is largely attributable to this factor; the Fed survey also revealed that the average American family's net worth declined from $126,400 in 2007 to $77,300 in 2010 - which places it at its lowest level in the past 20 years.
Recessions inevitably impact the stock and bond markets. The stock market was hit hard by the Subprime Meltdown of 2008, and many Americans saw their investment and retirement portfolios plummet in value almost overnight. Although the markets have largely recovered since then, many investors have been fearful to get back in and recoup their losses. And interest rates are also likely to stay at their historically low level for the foreseeable future, which means that fixed income investors can most likely expect to receive a very low return on their money for some time to come.
The Bottom Line
If the economy does take another downturn, then the factors listed above will only intensify. Review your investment portfolio carefully and make sure that you are taking the right amount of risk. This may be a good time to limit your exposure to volatile sectors of the economy such as technology. But if you are lucky enough to have a secure income, then this could be an excellent time to look at purchasing real estate. If you already own a home and are looking for a viable investment or additional income, then you may want to consider purchasing a rental property or two. As mentioned previously, property values always drop during recession, which makes this an excellent time to buy. And if you feel that there is a real chance that you could be looking for work again if the economy worsens, then you should increase your short-term savings now so that you will have something to fall back on if you become unemployed. For more information on how a recession can affect your net worth and how you can prepare yourself for it, consult your financial advisor.