If Recession Hits: How To Be Prepared

Last Updated Aug 12, 2011 12:21 PM EDT

According to J.P. Morgan, the financial markets are now pricing in a substantial likelihood of a recession and a 30 percent decline in corporate earnings. If that were to materialize, it would make the current situation look like elementary school recess.

But I am not in that camp. I think things will improve. But that doesn't mean folks shouldn't plan for the worst. Right now, the average length of unemployment is around 40 weeks and the average job search takes over eight months. With this in mind, folks need to buckle up and check the strength of their financial safety nets.

So, over the next few days, I'll write about some of my financial moves to be prepared and soften the blow if the economy takes a dip again.

Build a Cash Cushion
With the average length of a job search today measuring a bit over eight months, building and maintain a sizable cash stock pile is critical. And a job search could take even longer if you are employed in a sector that's in turmoil. You also may need more time to shift your skills to a career with more opportunity. For this reason it's important to have at least six to eight months of cash on hand. You may want to err on the high side of this if you are the sole income earner or self employed. Consider these moves to increase your cash cushion:

Decrease your 401(k) plan contributions to the minimum required to collect your employer's company match (typically six percent of your pre-tax pay). The increase in net pay should be used to build up your emergency fund.

Eliminate all unnecessary payroll deductions, such as savings bonds or charitable contributions. Use this cash to bolster your savings.

Reduce your income tax withholding from your pay, especially if you typically receive a tax refund. Over 70 percent of all tax filers, over 95 million folks, received a tax refund each year. The average tax refund received this past tax season was over $3,100. Of course a large tax refund each feel good, but larger take-home paycheck NOW will help you to build your cash cushion more quickly.

Here's why getting a tax refund every year is not a smart thing: when you get a large tax refund, this simply means that you are having too much in taxes deducted from your pay. Since you only settle this overpayment up with the IRS once each year at tax time, you are letting the IRS keep this money as an interest free loan. Would you overpay your cable bill or over pay your rent by several thousand dollars just to ask for it back a year later without any interest? Of course not!!!

If you could use the cash instead of giving the IRS a zero percent interest loan, then reduce your tax withholding by increasing your withholding allowances, changing your withholding status or both. Here is how to do this: Complete a new Form W-4 and submit it with your employer's payroll department. Do this now so that the change will be effective for the next pay period and you can then put the additional cash in your pay to work increasing your savings.

Check back in few days when I'll write about steps to take to prepare your savings and investments.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.