Investing During a Recession: What You Need to Know
There’s no escaping the fact that economic downturns and periods of market volatility are part of the normal cycle of every economy. However, there’s no need to panic. With the right economic research and investing strategy, you can grow your portfolio and profit from certain investment vehicles during a recession.
While there certainly isn’t a recession-proof investment, there are certain asset classes that have proven profitable during unfavorable market conditions.
In this article, we’ll provide vital tips for investing during a recession, discuss ways on how to invest before a downturn, and talk about which investments you should avoid during this period of economic uncertainty.
What Will I Learn?
- Are We in a Recession?
- Tips for Investing During a Recession
- Five Investments to Consider During a Recession
- Which Investments Should You Avoid During Economic Downturns?
- How to Invest Before a Recession
- Final Thoughts
- Frequently Asked Questions
Are We in a Recession?
A recession is reportedly characterized by two or more consecutive quarters of declining gross domestic product (GDP), which is what happened during the first half of 2022.
The body that keeps track of US recessions, the National Bureau of Economic Research (NBER), employs a significantly broader definition. According to the NBER, recessions are classified as a major fall in economic growth that is distributed across the economy and will last more than just a few months.
Moreover, the NBER measures recessions using a variety of indicators, including employment, industrial production, and personal income. The start of a new recession has not yet been declared.
Tips for Investing During a Recession
When you invest during a recession, you can try to time the market by purchasing shares at low or declining prices in the hopes that they will rise soon.
However, there are a number of variables that might affect how well you manage your finances during a recession, including how long you have before you require access to the funds and your risk tolerance. Let’s take a look at a few tips to help you make the most of your investments.
Use Dollar-cost Averaging
It might be a good idea to keep investing when a recession hits, whether you typically make contributions to an individual retirement account, a 401(k), or non-retirement investment accounts via a broker.
Whether the stock market is going up or down, the dollar-cost averaging technique enables you to invest the same amount of money constantly. As a result, you would purchase more shares of the stock at lower prices and fewer shares at higher prices.
Be Prepared to Invest Long-term
You probably won’t need to remove money from your investments for at least 5 to 10 years if you’re purchasing stocks or stock mutual funds. Because of this, you won’t have to worry too much about sudden fluctuations in the stock market.
However, you would need to set sufficient funds in bonds or cash to access the money sooner. To put it another way, taking withdrawals from your equities portfolio during a bear market can cause your savings to be depleted.
Adjust Your Portfolio
If you see prices dropping, you can adjust the composition of your holdings. Then, you change your holdings or bring your investment strategy back in line with your initial objectives.
Suppose your intended balance is 60 percent stocks and 40 percent bonds. A recession would result in a fall in the stock component and a rise in the bond portion.
In that case, to restore balance, you would sell some of your bonds and add the proceeds to your equity holdings, bringing your portfolio’s balance back to the target 60 percent stocks and 40 percent bonds.
Five Investments to Consider During a Recession
When markets collapse, many investors immediately sell their positions in an effort to ease the pain of losing money. The truth is that the market is actually improving future rewards for those who invest in discounted stocks at this time. A drop in stock prices means your possible future profits are even higher because successful organizations are well-positioned to succeed in 10 and 20 years.
Therefore, when prices are often lower, a recession is the ideal time to maximize your returns. If undertaken during a recession, the investments we have listed below have the potential to yield greater returns over time.
1. Precious Metals
Precious metals such as gold and silver have historically held their value. When economic downturns cause uncertainty, many investors turn to these assets. That’s because when the price of currencies start to plummet, the value of these assets increases.
A recession here in the U.S. would not impact the price of gold since it is in demand globally. The world would continue to regard gold and other valuable metals as precious.
Contrary to the erratic prices of other investments, such as stocks or bonds, precious metals are liquid commodities that can be converted into cash in the majority of countries.
What’s more, these assets never age or lose their structural integrity. Gold that is kept in storage will always be available as a secure investment, unlike cash that may be damaged or stolen by hackers and cybercriminals, making it an excellent commodity to invest in before or during a recession.
2. Dividend Stocks
It’s a good idea to include some dividend stocks in your investment portfolio if you would like it to be a little less volatile. Your portfolio will move less when you invest in high-quality dividend stocks because these stocks tend to vary less than other stock types (growth stocks, for instance).
Additionally, they may provide a cash dividend to provide some income as you await changes in the market.
Suppose you’re not confident in your ability to choose dividend-paying stocks. In that case, you can purchase a dividend stock fund to reap the benefits of diversification’s lower risk levels while still receiving a respectable dividend return. When you buy shares at a discount, the total yield will be greater.
Investing in defensive stocks like consumer staples and healthcare stocks is one of the best ways to ensure that you receive consistent earnings during periods of uncertainty.
3. High-yield Savings Account
Because most recessions don’t last very long, investing in cash might be a good way to take advantage of low prices.
What’s more, you have a lot of possibilities with cash. Having cash on hand can serve as your emergency fund.
You can spend it, if necessary, on consumer staples. Moreover, it will allow you to make an opportunistic investment in the event that the stock market unexpectedly declines or you subsequently find the perfect home.
Keep in mind that having a lot of cash on hand certainly keeping too much cash has its drawbacks. Your savings may be subject to inflation, and it’s unlikely that you’ll earn enough interest to make up the difference. Therefore, it’s best to deposit your money in a high-yield savings account.
4. Stock Funds
An excellent approach when investing during a recession is to purchase a stock fund, whether it be a mutual fund or an ETF. Stock funds often have lower volatility than portfolios of a few stocks. If you can handle the short-term volatility, it offers the possibility of substantial long-term gains.
An excellent option is an index fund based on the Standard & Poor’s 500, which contains hundreds of the greatest firms in the US and has historically returned roughly 10 percent. You have ownership in the stock market as a whole rather than attempting to predict the winners.
5. Real Estate
Real estate can be an appealing investment during a recession. Firstly, you might be able to purchase properties at a lower cost than in times of a thriving economy. The value of your property investment could then increase as the economy grows and consumers have more money to spend.
Secondly, mortgage rates are generally considerably lower than they would be otherwise, which means that you will likely be able to secure a mortgage at a much better price. A desirable mortgage payment can be fixed for years or even decades, guaranteeing you will still have a low monthly repayment even if interest rates increase later.
Which Investments Should You Avoid During Economic Downturns?
Not all investment vehicles will prove profitable during a recession. Let’s talk about which investments you should avoid during an economic downturn.
Options and Other High-risk Assets
The truth is that options and other high-risk investments are not appropriate during recessions. Options are a wager that the price of individual stocks will finish either above or below a specific price by a certain date.
Although they are a high-risk, high-reward approach, the unpredictability brought on by a recession increases the risk of losing money.
With options, you must accurately anticipate not just what will happen to the price of a stock over time but also when it will occur. Should you make the wrong guess, you can end up having to pay more money than you had planned to contribute or lose your entire investment.
In general, bonds tend to be safer than stocks. Still, it’s vital to keep in mind that there are favorable and unfavorable times to purchase bonds, and such times are typically associated with changes in the market’s interest rates.
This is due to the fact that bond prices are driven higher by falling interest rates and lower by rising interest rates. These changes will have a greater impact on long-term bonds than they will on short-term bonds.
Investors could turn to the relative security of bonds as they begin to foresee a recession. Typically, they anticipate the Federal Reserve will cut the interest rate, which will support rising bond prices. Therefore, if rates haven’t already dropped, entering a recession can be a good time to buy bonds.
Keep in mind that when interest rates are anticipated to increase soon, it is one of the worst periods to purchase bonds. This happens during and following a recession.
Bonds may appear safe to investors, particularly when compared to the volatility of individual stocks. Still, once the economy begins to expand again, interest rates will likely rise, and bond prices will start to decline.
Companies with High Debt Loads
Businesses with large debt loads that are susceptible to rising interest should be avoided during a recession.
Before and during a recession, the shares of highly indebted corporations typically see considerable declines. Investors discount the stock price to account for the risk that the debt on the company’s balance sheet poses. The firm might not be able to afford the interest on its loan and might have to default if sales decrease, which is normal during a recession.
How to Invest Before a Recession
Although no assets are recession-proof, there are certain investment vehicles that could provide good returns when you invest before the start of a recession.
Defensive or cyclical stocks consistently pay dividends and generate steady earnings, regardless of the condition of the general stock market, making them the perfect investment vehicles to invest in before a recession.
The healthcare sector comprises biotech and pharmaceutical companies, and the consumer staples sector includes personal and household products, food and drinks, and even alcoholic beverages and tobacco.
In the bounce back and recovery stage of a recession, these industries generally don’t experience the same rapid growth as others, such as computer technology and consumer discretionary goods like luxury items and household services and products.
Look for Companies with Strong Balance Sheets
To create a recession-proof portfolio, you should look at the past performance of a company. If the firm has seen a significant decline in the past, it’s probably a good idea to steer clear.
Suppose you intend to invest in precious metals. In that case, it’s important to find a reputable dealer to ensure that you’re getting high-quality products. Moreover, storing the precious metals in a secure storage facility will ensure that your investment isn’t stolen or lost.
Although the National Bureau of Economic Research has not announced a recession, many Americans fear that an economic downturn looms. Although no investments are truly recession-proof, there are certain asset classes you can invest in to secure your financial future amid a market downturn.
It pays to have investments in addition to a fixed income to protect your financial position. From real estate to stocks, there are many ways to invest during a recession.
We highly recommend investing in precious metals before and during economic turmoil because they typically perform very well during a recession. It’s important to remember that long-term investors tend to profit the most when they invest during a recession.
Frequently Asked Questions
Learn more about investing during a recession in the section below.
1. Is it a good idea to invest in growth stocks during a recession?
Yes. Growth stocks can perform well during market downturns. However, it’s important to invest in companies that have low debt and strong balance sheets to prevent losses.
2. What’s the best way to invest during a recession?
Long-term thinking can help you weather bear markets. Spending the same dollar amount on investments, whether the market is increasing or dropping, is the goal of techniques such as dollar-cost averaging. As a result, you cut your average cost, which will ultimately increase your long-term earnings when the market and economy recover.
3. What are the best assets to buy on the stock market during a recession?
Long-term stock purchases can be beneficial, particularly if they include dividend-paying stocks. In addition to stocks, bonds can also offer a certain level of security, whereas real estate can generate rental income.