How to prepare for a recession

The chaos in the world's financial markets continued this week, with America's S&P 500 suffering its worst one-day fall for over 20 years, and the FTSE 100 falling back below 4,000 points after a strong rally at the start of the week.

Although Gordon Brown's bail-out may have mitigated the risk of a major UK bank collapsing, it was not enough to abate investors' fears of a deep and painful recession.

For consumers, the last few weeks have been an unsettling time, as Icelandic banks offering top savings rates have gone bust, and the UK's biggest mortgage lenders have been partly nationalised. Though oil prices have begun to fall, inflation has hit a 16-and-a-half-year peak, and unemployment has risen to its highest level in a decade.

With economic conditions looking grim over the months ahead, now is the time to make sure that you're prepared for the worst. We look at the five questions you need to be asking.

Are my savings beating inflation?

With inflation now at 5.2 per cent – and more for certain groups of society – you need to be earning a high rate on your savings just to ensure that they're keeping pace with the cost of living. If you're paying tax on any interest you earn, you need to be earning more than 6.5 per cent as a basic-rate taxpayer to beat both tax and inflation, and more than 8.5 per cent if you're a higher-rate taxpayer.

Maximise your savings interest by using all of your ISA allowance. Each taxpayer can put up to £3,600 into a cash ISA every year, and there will be no tax to pay on any interest you earn. As of April this year, you can now transfer old cash ISAs to other providers without losing your tax benefit. The best no-strings, instant-access cash ISA deals for transfers are currently offered by the Principality Building Society and Birmingham Midshires, paying 6 per cent. Or, if you're looking to open a new ISA, you can get 6.05 per cent with Egg.

Once you've used up your ISA allowance, the best savings rates are those that make you tie up your money for a year or more. Anglo-Irish bank and Icici offer more than 7 per cent on this type of deal.

When does my mortgage deal come to an end?

If you've taken out a mortgage within the last few years, find out when your deal comes to an end. Although the Bank of England reduced base rates by 0.5 percentage points last week, most banks have been repricing their tracker mortgages upwards relative to base rate over the past week, so you'll need to move fast to get the best deal.

David Hollingworth of London & Country, the fee-free broker, says that it's possible to reserve rates up to six months in advance of your completion date, so if you've only got a few months to go until your current deal ends then now's the time to shop around.

If you don't remortgage before your current deal ends, you'll be pushed on to the bank's standard variable rate, which is likely to be at least 2 percentage points above base rate and could add hundreds of pounds a month to your repayments.

It's especially important to move quickly if you don't have much equity in your home. Most lenders are now reluctant to lend more than 85 or 90 per cent of a property's value; as house prices continue to fall, many homeowners are seeing the equity in their home eaten away.

At times like these it's well worth using a broker, such as London & Country (www.lcplc.com), to ensure that you get the best deal.

Could I survive if I lost my job?

Most people have numerous financial commitments that have to be paid whether they're in work or not. So what you would do if you lost your job? Would your mortgage lender let you stop paying your mortgage for a few months? Would your partner's salary be able to cover your outgoings?

Most financial advisers recommend keeping between three and six months' worth of salary in easily accessible savings to cover you in an emergency. In tough economic times, it is worth taking out income-protection insurance, which will pay out should you end up being out of work for a longer period.

Matt Morris of Lifesearch, the independent broker, says that policies will usually start paying out three months after you stop work. You can get policies that will pay out immediately, but the premiums will be more expensive.

The cost of income protection also varies depending on age, health and profession. As an illustration, Morris says that a 35-year-old, non-smoking male office manager would need to pay around £31 a month for protection of £1,000 a month. This would pay out for up to 30 years if they were unable to work due to sickness, or for up to a year if they ended up unemployed.

Emma Walker of moneysupermarket.com, the comparison site, warns people to read the small print before buying a policy. Some policies will be rendered invalid if you already knew that there was a high risk of losing your job when you took it out.

Is my pension money invested wisely?

Since the credit crunch started, savers have seen billions wiped off the value of their pension funds. But with markets looking to be somewhere close to the bottom of the current cycle, now is not the time to lose your nerve and move out of the equities. Instead, it's the perfect time to review your holdings and position yourself to take advantage of the eventual recovery.

Broadly speaking, if you're a younger investor – below the age of 45 – you should have most of your pension invested in equity markets – but it's worth diversifying across different global markets. Japan, for example, has performed very differently to Western markets over the past two decades, and may be worth holding in addition to more core holdings of UK, US and European equities.

For people within a few years of retirement, you should hopefully have moved most of your money out of equities and into more conservative asset classes such as bonds and property. If you're still invested heavily in equities, don't sell out and crystalise your losses while the markets are in the doldrums.

Can I cut my bills?

At times like these, you can never save too much. Review your monthly expenditure to see whether you can cut out a few non-essentials, or simply find cheaper alternatives for the things you can't do without.

If you haven't reviewed your energy bills in the past few years, you can probably save money by switching. To find the best energy deals, see websites such as uswitch.com and switchwithwhich.co.uk. Switching phone suppliers can save you cash as can getting your phone and broadband from the same provider.

Also consider spending less on going out and clothes and making packed lunches instead of buying sandwiches.

Five more questions to ask

* Are you getting the best rate of interest on your credit card and loans? If not, you may be able to switch to a 0 per cent deal.

* Are you shopping around for your car and home insurance? Most insurers will up your premium each year – by shopping around, you could secure yourself a better deal.

* Are you saving enough? You should have at least three months' salary in a savings account.

* Could you save money by cycling to work? Trading in the car or Tube for a bike could save you thousands a year, and you might even be able to cancel your gym membership, too.

* Are you claiming all the benefits you're eligible for? If your household income is less than £50,000 a year, you could qualify for tax credits.

If you're unsure of whether your money is invested in the right place, seek professional advice. To find an independent adviser in your area, visit www.unbiased.co.uk.