Let us assume the worst-case scenario that the recession does come through due to the collapse of the housing sector which in turn would bring down the economy in a ripple effect. Well our assumption might as well come out true since home sales are cooling and prices are beginning to fall. Marilyn Lewis writes about how the prices of real-estate are declining in major metros in the article "Boom to bust, almost overnight" at MSN Money.

Now the question that arises and needs to be addressed is: "How do we take care of our investments and our daily needs during a recession?" After all we have invested our blood and sweat through our hard-earned money in various instruments such as stocks, mutual funds, bonds, real-estate, etc. If a recession does wipe out a significant part of our wealth in a very short period of time, it would really be of grave concern. It may land us in unprecedented trouble if we are unprepared. Since we do not like to be caught unaware we decided to dig deep in and do some research into the issue.The jewels that we unearthed in our digging helped us understand the phenomenon of recession and how we can prepare ourselves for it. They are presented as follows:

• Recession is defined as a period of economic retraction; when the economy actually gets smaller. Generally, two months of decline in the Gross Domestic Product (GDP) or a sharp rise in the unemployment rate, are red flags that a country is approaching, or in the midst of, such an economic contraction [2].
• Wiki's definition and more info (technical jargon) for recession.
• When did the last recession occur?
• The last official recession was from March to November 2001. Here is an entire list of official dates of economic recessions in the US.
• How does the market behave during a recession?
• During a recession people spend less money since household incomes decrease. Consequently companies make less money, resulting in lower earnings and thus lower share prices. As a result the stock market gets hit first and hardest [2].
• The lack of demand that hits the companies causes them to decrease inventories, cut down on productions and draw on their stored resources. This phenomenon makes employers lay off employees that are no longer needed causing unemployment to go up [2].
• Work becomes scarce, there are more employees than employers and this causes the general wages to spiral down [2].
• With falling output during a recession, revenue collections for governments go down. Fiscal imbalances may also be aggravated because the recession leads to the need for additional expenditures on social safety nets [3].
• The market is a bear market or a slow economy [2].

Source: http://en.wikipedia.org/wiki/Image:Business_cycle_01.png#file

How to prepare for a recession?

• The first thing that we have to do is to keep a roof over our family's head. Since the risk of lay-offs drastically increases and we can lose our jobs any time we should first take care of our basic needs of food and shelter for the entire family. Most certified financial planners agree on the following steps:
1. We should start putting cash into a reserve / emergency fund. Needless to say, we have to cut down on our expenditures. This does not necessarily imply being a miser but rather it implies being frugal.
   
2. The fund should be equal to at least six months worth of living expenses.
3. It should be kept in a savings account so that we can access it immediately in case of lay-offs i.e. keep the fund in liquid form and not CDs [2].
• After the basic needs are taken care of, the next step is to protect our portfolios. The most critical questions to be pondered about are:
• "Will the economy turn around soon or sometime during our lifetime?"
• "Which sector or big companies will still be the backbone of the economy in a decade or perhaps when the economy turns around ?"
• Next we have to establish a practical plan for saving our nest egg from the attack of the recession:
• Revisit our goals.
• Estimate / Realize our risk tolerance limits.
• Review and adjust our portfolio accordingly.
• Consider reviewing our insurances [life, health, auto, real-estate, other] since lay-offs might affect them.
• If we feel nothing is worth investing in during the times of recession we should hold on to our cash. There is an old saying "In a recession cash is king." But we must also retain a balance, so that we don't sell off our precious and valuable (in future) investments (just because their prices are falling) in a panic mode to get some cash.
• Some interesting recession phenomena:
• It is to be understood that although there might be severe problems during a recession it does offer opportunities to make some serious money if we can overcome our fears and worries. Most investors know that the economy will turn around (history repeats itself) and that all of us will be fine in the long run.
• But the (temporary) huge decline in stock prices paralyzes us with fear and often when we need to invest or stay put, we end up selling up our stocks !
  
• Also, there might be situations where we have identified profitable (future) sectors but we cannot invest in them due to lack of funds.
• What is a testament to Wall Street's stupidity is that during the times when these stocks fall the brokers recommend selling! The time to sell was before the stock price declined! If you believe that the United States economy will survive, then the short-term bumps in the road shouldn't matter in the slightest [2].

Personally we feel we have to remain calm and not act under the influence of fear. The figure above shows that recession does bring in a trough, which only implies that things can only improve from there onwards. We all know that the stock market takes turns in being bears and bulls. So if the bear is here the bull cannot be far behind. US has the advantages of a large human capital, well-developed capital markets, flexible labor markets, some of the best possible infrastructures in all sectors in the world and relatively positive demographic trends - with these strengths and a great positive outlook from Americans it would not be long before the US economy is up and firing on all cylinders.

We request our readers to leave comments on their opinions or ideas about tackling the issues / problems related to a recession. The experience of those who have already faced a recession will help us to learn the hands-on tricks of dealing with the tough times that lie ahead.

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References

[1] Nutting, Rex - "Recession will be nasty and deep" - Market Watch - Aug 2006.

[2] Kennon, Joshua -" Recession 411 - What it is and how it should affect your investments?"

[3] "Does IMF Fiscal Policy Advice End Up Hurting The Poor ? - Transcript of an International Monetary Fund Economic Forum, Washington D.C, April 2003.

[4] Carrie Coghill - "Post Recession Financial Planning Principles" - Physicians News Digest - May 2003.