On paper, things look pretty good right now. The S&P 500 is up 15% so far this year, inflation has cooled significantly, and the unemployment rate is relatively low.

However, some economists believe that there are some indicators that the economy is slowing down and that a recession could strike within the next 12 months.

Taking some steps now — when the country's financial situation is stable — can help you recession-proof your savings and protect your finances.

What is a recession?

A recession is a term that inspires fear in politicians, economists, and business owners, but what does it really mean? Although precise definitions vary, the National Bureau of Economic Research (NBER) — a private, nonprofit organization that analyzes economic conditions — defines a recession as a period of significant economic decline that lasts for several months.

The NBER looks for several factors to determine if a recession has occurred, such as higher unemployment rates, home prices and sales, stock market declines, and wages.

Recessions are a natural and unavoidable part of the economic cycle. In fact, there have been over a dozen recessions since World War II. The most recent recession was in the spring of 2020, when the COVID-19 pandemic affected the country.

In general, recessions occur every few years, and they typically last for about 10 months.

7 ways to recession-proof your savings

During a recession, you may experience the following issues:

• Annual percentage yields (APYs) may decline: To stimulate the economy and encourage spending, the Federal Reserve will often slash rates. As a result, loans will become less expensive, but the rates on deposit accounts — such as savings accounts and certificates of deposit (CDs) — will also decline. That means any money you have saved will grow at a much slower pace.

• Earnings may stagnate: During a recession, unemployment levels are up, and workers' wages tend to stagnate, so you may not qualify for a raise. Many businesses also initiate layoffs.

• Lenders may tighten their standards: During a recession, lenders often institute stricter lending requirements for borrowers, making it more difficult to qualify for new credit or loans.

To minimize the impact of a recession on your financial well-being, follow these steps:

1. Review your budget

It's a good idea to check your budget and review your spending to identify any corners you can cut. Canceling unnecessary services or subscriptions, reducing the number of streaming services you use, and sticking to a meal plan and grocery list are all small ways to trim your spending.

If money is tight, you may need to take some more drastic measures, such as adding a roommate to reduce your housing expenses, instituting shopping freezes, or shopping around for cheaper insurance.

Read more: 7 ways to save money on a tight budget

2. Build an emergency fund

It's unavoidable: You're managing your finances well and making progress toward your goals, when an unexpected problem pops up. Perhaps your cat becomes ill and needs to visit the emergency vet, or your car refuses to start. Whatever the case may be, those emergencies can leave you scrambling to cover the cost, or you may end up using a high-interest credit card to foot the bill.

Building an emergency fund — a safety net in a separate savings account — is a critical step to avoid unnecessary debt. Although experts recommend saving enough cash to cover at least three to six months of expenses, the most important thing is to start small. Saving $1,000, $50, or even $100 can provide some financial cushion against the unexpected, and you can add to it over time.

3. Move cash to a high-yield savings account (HYSA)

To make your savings work as hard for you as possible, move a portion of your cash to an HYSA. Nationally, the average rate for savings accounts is under 0.50%, but the best high-yield savings accounts offer rates as high as 5% APY or more.

Rates tend to decline during a recession, but an HYSA will provide a higher yield than you'd get from a basic checking or savings account.

4. Lock in higher rates with a CD

As mentioned earlier, the Federal Reserve typically cuts rates when we're in a recession. That decision causes the rates on deposit accounts to decrease.

However, there are some deposit products that allow you to earn a fixed interest rate over a set period of time, such as CDs. Opening an account will allow you to lock in today’s competitive rates for months or even years, maximizing your money. (See our picks for the best CD rates available today here.)

5. Pay down debt

One of the best investments you can make is to pay down high-interest debt. Credit cards can have rates well into the double digits, and even car loans and personal loans can be expensive in today’s high-interest-rate environment. Paying extra toward your balances will help you save money on interest and get rid of your debt faster.

6. Look for other streams of income

Because wages tend to stagnate during a recession and layoffs become more common, developing other streams of income is an excellent way to recession-proof your finances. You could pick up a side hustle, such as delivering groceries, walking dogs, or developing social media content for local companies, to earn extra money.

Or you can learn a new skill, such as graphic design, video editing, or coding to expand your options and increase your earning potential.

7. Stay the course

If you haven't gone through a recession before, it can be a scary experience. When you check the balance of your 401(k), individual retirement account (IRA), or investment account during a recession, you may be shocked to see large losses and account declines.

However, you shouldn't panic. Although it can be scary to see such steep drops, recessions are normal, and investments tend to ebb and flow. Avoid the impulse to cut your losses and sell off your holdings; that approach only locks in the losses. Instead, continue contributing regularly to your retirement or investment accounts and focus on long-term performance.

Frequently asked questions (FAQs)

Are savings accounts safe during a recession?

If your savings account is with a financial institution backed by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), your money is safe.

Thanks to FDIC and NCUA insurance, your deposits at these institutions are insured up to a maximum of $250,000 per person, per institution, per ownership category.

The rates on your savings account may drop, but your money is otherwise protected from losses or bank failures.

What types of investments are recession-proof?

No investment is completely safe or a guarantee. However, more conservative options like bonds can be a good option. For many people, a diversified investment portfolio — meaning a portfolio that invests in a broad range of companies and industries — is a good option. If you aren't sure if you have the right investments or the correct level of portfolio diversification, meet with a financial adviser to review your situation and goals and adjust your investments.

Should I reduce my retirement savings during a recession?

Unless you're at risk of falling behind on your bills, such as your mortgage payment or electric bill, try to keep up with your current retirement savings rate. Continuing to contribute during a recession will help your money grow and compound, setting you up for a more secure retirement.