How Would a Recession Affect Your Finances

What is the definition of a recession?

In simplest terms, a recession means that the economy is in a slow down or dormant phase, where unemployment rises, prices of certain items like gas or food increase, and company stock prices drop.

Recessions hit us when Net Domestic Product and Gross Domestic Product (GDP)-the total market value of all goods and services produced by a country within a specific time frame—shrinks for 6 months. If you hear people talk about “inflation”, this means your dollar has less buying power today than it did yesterday due to the higher cost of the item in demand.

The good news is, these are recurring cycles of our economic and business reality, so as proven by history, we'll see a growth phase again in the future.

How will a recession affect my investments?

During a recession, investments in stocks, bonds, and other assets can lose their value, decreasing your overall net worth. When consumers tighten their wallets, company sales dry up. When company sales dry up, the value of these companies (aka their stock prices) drop.

The important thing is that markets do rebound, especially if you have a diversified portfolio and a long-term investing mindset. So, if you're considering selling your investment at a loss, try your best to wait it out, if you can. If you do decide to sell, consider the tax impact of selling those investments, such as capital gains or losses. Also, when market prices are down, it presents an opportunity to buy stocks at a lower price. If you have a shorter time horizon for your investments, consider moving to a more conservative risk profile which will temper some of the volatility that you might see over the short term.

Either way, now might be a good time to talk to a financial advisor to create and execute your investment strategy based on your financial goals.

What about real estate?

Real estate may also be vulnerable, particularly when buyers are unsure where mortgage rates are headed and sellers may be trying to liquidate their real estate. People's wobbly faith in their job security and lack of savings may also stop them from rushing out to bid on their dream home, knocking down house prices even more.

If you already own property, you may consider staying the course and riding out the economic storm. If you're looking to buy, you may find a bargain, but be careful not to overextend yourself. Talk to a mortgage broker and a financial planner before making your move.

What are the tax implications of selling my assets during a recession?

You may need to liquidate investments if you need the money. For some investments, you might have to pay taxes if you choose to sell.

 

For non-registered investments, if you sell off an investment and make more than you originally paid, that's a capital gain. In Canada, you must claim 50% of that sum as part of your taxable income. If you sell at a loss, you can apply against any current year capital gains or offset any capital gains you made over the last 3 years.

For example: Last year, Joanne sold shares valued at $2,500 that she purchased for $1,000, which generated a capital gain of $1,500. She had to report the gain, and add 50% of the gain to her income ($1,500 x 50% = $750) onto Schedule 3 of her income tax return.

This year she sold shares costing $2,200 for $1,000, which generated a capital loss of $1,200.

Since Joanne has to report the loss, ($1,200 x 50% = $600), onto schedule 3, she can apply the $600 against her capital gain of $750 from last year, using schedule T1A.

As a result, last year's net capital gain will be reduced from $750 to $125. Joanne will receive a refund for any tax she paid on that gain once the CRA processes the adjustment.

 

For your RRSP, a registered account, you may have taxes withheld when you withdraw. The current withholding tax rates for withdrawing funds from an RRSP are as follows: 10% on amounts up-to $5,000; 20% on amounts over $5,000 up-to and including $15,000; and. 30% on amounts over $15,000. Your total tax payable will be based on how much income you receive in that tax year, so be mindful about how these withdrawals might affect the tax bracket you are in.

 

What if I sell my real estate investments?

With regard to real estate, if you sell your principal residence, which is the main home where you and your family live throughout the year, you don't have to pay capital gains taxes thanks to the principal residence exemption.

NOTE: To qualify as a principal resident, your property has to be a housing unit like a house, cottage, condo, mobile home, etc, that you, your spouse or any of your kids have actually lived in. See what qualifies as a principal residence here.

Investment properties such as rental properties you own, on the other hand, must be reported for capital gains and loss, and you may be taxed if there is a capital gain. So before making any decisions, it's always a good idea to talk to a tax expert.

Preparing for inflation and recession

We know that higher prices are coming our way due to the higher cost of goods being imported into Canada. Stagflation, the combination of higher prices and slow economic growth is also a clear possibility. While you can't make things cheaper, you can adjust your finances to inflation-proof your money. Here are some tips to ride out the recession with minimal damage.

1. Build your emergency fund

Having an emergency fund, or knowing where you access emergency funds to ride out uncertain market conditions can offer you peace of mind.

Exactly how much cash should you have available for a rainy day?

Most experts suggest a 4-6-month cushion as a comfortable minimum. Figure out how much cash you need every month to live, and then multiply that figure to get a good idea on how much money you need to save. Using free budgeting apps can help manage your budget and calculate your net worth so you always know where you stand.

 

If you find yourself needing emergency funds and you don't have the money readily available, consider a lower-interest credit product, such as a line of credit, rather than living off of higher-interest credit cards.

Take it one step further and think about how you can earn extra money. Perhaps you have an empty bedroom you can rent to a student, or there's a skill you have that can be turned into a side hustle?

2. Reign in your spending

Consider what you need vs. what you want. This might be the time to forego bigger non-necessities. It might not necessarily mean going without, it could mean just dialing it back. Think about going for a staycation instead of an all-inclusive in the Caribbean, or buying a used vehicle instead of new. Only spend what you can afford, and avoid going into debt for things that isn't absolutely necessary.

3. Deal with debt

During a recession, racking up debt on your credit card can create more problems for you. Credit cards have notoriously high interest rates, which makes servicing those debts even harder.

 

Prioritize paying off any outstanding debt you owe by making a record of how much you owe, where the debt is coming from, and what the monthly minimum payment is.

Whether you choose to pay off the smallest debt first, combine all your credit card balances into one monthly payment for a lower interest cost, or tackle the debt with the highest interest rate, it's never too late to create a repayment plan to help you gain debt freedom.

4. Keep a budget

Keeping track of your expenses is eye-opening, especially with easy-to-use budgeting software. The last thing you want to do is spend more than you make. A budget is also a good way to identify where you can cut back and save, or whether you need to find more income to pay your bills.

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