How to Invest During a Recession
The first half of 2022 caused many investors to be worried about how to invest during a recession. With inflation at levels not seen in 40 years, stocks falling into bear market territory, and the U.S. economy contracting for two straight quarters, investors were searching for strategies to invest during these volatile times.
Looking at your brokerage or 401(k) account may cause a sense of dread when the economy or stock market looks to be on shaky footing. You may wonder how you can navigate the moment. Just because your investments may be trending downward, don’t let fear lead you to make impulsive decisions like pulling your money out of the market and locking in losses.
Read on to learn why staying the course during a recession can have an upside, and sometimes entering the market even in the depths of a downturn might offer some long-term rewards.
What You Need to Know About Investing in a Recession
A recession describes a contraction in economic activity, often defined as a period of two consecutive quarters of decline in the nation’s real Gross Domestic Product (GDP) — the inflation-adjusted value of all goods and services produced in the United States. However, the National Bureau of Economic Research, which officially declares recessions, takes a broader view — including indicators like wholesale-retail sales, industrial production, employment, and real income.
The point is that the markets tend to price in those indicators, so much so that you may see the prices of stocks start to drop (and bond prices start to rise) even before a recession is officially called. For example, the S&P 500 Index declined about 57% from October 9, 2007, through March 9, 2009, a bear market that started two months before the Great Recession, which lasted from December 2007 through June 2009.
From those lows in March 2009, the S&P 500 delivered a return of 400% through February 2020, surpassing the previous peak in April 2013. Those that stayed in the market despite unprecedented economic declines were still able to experience a positive return.
But that stock volatility can give investors the jitters — and that emotional state that can be contagious.
Behavioral finance experts have dubbed this tendency “herd mentality,” which means you’re more likely to behave similarly to a larger group than you realize. Combine that behavioral bias with another common one — loss aversion — and you can see how emotions can lead some investors to make impulsive choices in a moment of panic or doubt.
However, there is some good news: history shows that most recessions don’t last as long as you might think — about 17 months, according to the National Bureau of Economic Research (NBER). So while an economic downturn can be scary while it lasts, it’s likely that time is on your side.
By staying the course and sticking with your investment strategy (and not yielding to emotion), the market recovery could help you recoup any losses and possibly see some gains — especially if you buy the dip (when prices are low).
As investors witnessed firsthand during the market swoon that accompanied the arrival of the pandemic in March of 2020, sometimes declines don’t last very long. The pandemic-related bear market lasted for about a month, while the recession lasted about two months.
Investing Strategies for a Recession
The following are a few investment strategies that may help investors weather a recession:
While it’s critical for investors to stay true to their long-term strategy during a recession, what about investing new money? This is where the concept of dollar-cost averaging is important for investors to keep in mind.
Dollar-cost averaging, simply put, is a systematic way of investing a fixed amount of money regularly. It’s often used to describe the way most people invest, on a paycheck-by-paycheck basis, through workplace 401(k) and 403(b) plans.
This approach spreads the cost basis out over a long period of time and a wide range of prices. By doing so, it provides a degree of insulation against market fluctuations. During times of rapidly rising share prices, the investor will have a higher cost basis than they otherwise would have had. During times of collapsing stock prices, the investor will have a lower cost basis than they otherwise would have had.
Taken together, then, dollar-cost averaging can help you pay less for your investments on average over time and help to improve long-term returns.
Buy and Hold
Because most investors invest with a long-term time horizon, it’s best to employ a buy and hold investment strategy. This strategy can often be paired with a dollar-cost averaging strategy.
In short, a buy and hold strategy is a passive strategy in which investors buy stocks, exchange-traded funds, and other securities and hold on to them for a long time.
By buying and holding, investors believe that they are likely to earn long-term investment returns despite whatever short-term market volatility may come their way. They think an extended time horizon allows them to ride out short-term dips in the market.
This strategy can also help investors avoid emotional investing or trying to time the market.
Investors try to gauge how close or far they are from their goals because your time horizon determines how you invest. For instance, a younger investor may have a portfolio that’s heavier in growth stocks and lighter when it comes to bonds and cash.
For an investor nearing an important goal, like retirement, the priority may be safety and security or investments like high-quality (but lower-yielding) bonds. Over time, investors need to rebalance their portfolios, shifting the allocation of different asset classes. A younger investor may start with an allocation of 70% stocks and 30% bonds and cash. As you near retirement, that equity allocation would likely shift toward 50% stocks or even lower.
A recession can also be a chance to sell out of a mix of investments, owing to tax considerations. Investors can take advantage of tax-loss harvesting by selling stocks or mutual funds that have appreciated alongside those that have lost value. This strategy allows investors to use investments that have declined in value to offset investment gains and potentially reduce their annual tax bill.
When an investor wants to reduce capital gains taxes they owe on investments they’ve sold, tax-loss harvesting can allow an investor to deduct $3,000 in losses per year. As such, the strategy can be the silver lining on investments that didn’t work out.
Potential Investments During a Recession
It’s worth remembering some investments do better than others during recessions. Recessions are generally bad news for highly leveraged, cyclical, and speculative companies. These companies may not have the resources to withstand a rocky market.
By contrast, the companies that have traditionally survived and even outperformed during a downturn are companies with very little debt and strong cash flow. If those companies are in traditionally recession-resistant sectors, like essential consumer goods, utilities, defense contractors, and discount retailers, they may deserve closer consideration.
Some investors might also seek out even more defensive positions during a recession by buying real estate, precious metals (e.g., gold), or investing in established, dividend-paying stocks.
Additionally, some investors may look to move some money out of riskier investments like stocks, bonds, or commodities and into cash and cash equivalents. For some investors, having adequate cash on hand or having money invested in certificates of deposit (CDs) and money market funds may be a good option for a portfolio during a recession.
Bear in mind that every recession impacts different sectors in different ways. During the Great Recession of 2008-09, financial companies suffered — because it was a financial crisis. In 2020, biotech companies tended to thrive, but investments in energy companies have been hit harder owing to fluctuating oil prices.
As an investor, you must do the math on where the risks and opportunities lie during a recession.
What to Avoid In a Recession
During a recession, it’s important to remember two key tenets that will help you stick to your investing strategy. The first is: While markets change, your financial goals don’t. The second is: Paper losses aren’t real until you cash out.
The first tenet refers to the fact that investors go into the market because they want to achieve certain financial goals. Those goals are often years or decades in the future. But as noted above, the typically shorter-term nature of a recession may not ultimately impact those longer-term financial plans. So, most investors want to avoid changing their financial goals and strategies on the fly just because the economy and financial markets are declining.
The second tenet is a caveat for the many investors who watch their investments — even their long-term ones — far too closely. While markets can decline and account balances can fall, those losses aren’t real until an investor sells their investments. If you wait, it’s possible you’ll see some of those paper losses regain their value.
So, investors should generally avoid panicking and making rash decisions to sell their investments in the face of down markets. Panicked and emotional selling may lead you into the trap of “buying high and selling low,” the opposite of what most investors are trying to do.
Should Investors Expect a US Recession in 2023?
There is a possibility that the U.S. will be in or enter a recession in 2023, but it is not guaranteed. Factors that could lead to a recession include decreased consumer spending, rising unemployment, and decreased business investment.
In the first two quarters of 2022, the Bureau of Economic Analysis reported that GDP in the U.S. declined. To some, this indicated that the U.S. economy was in a recession. The stock market seemed to agree, with the S&P 500 down 25% in the year’s first three quarters.
However, others argued that the economy was not in a recession and that the GDP figures didn’t tell the whole story. After all, unemployment was still low, hiring was still robust, and consumer spending was growing.
Nonetheless, there is a chance that a recession will occur. Around the world, inflation is running high, so the Federal Reserve and other central banks are raising interest rates to try to cool economies to bring prices under control. But this hawkish monetary policy, along with factors like a volatile energy market and the Russia-Ukrainian War, may lead to a global recession that ultimately affects the U.S.
Investing during a recession is really what you make of it. While market volatility can spark investor worries, it’s possible to manage your emotions, stay in control of your investment strategy, and possibly come out ahead.
Certainly, you could start investing today by opening an account with SoFi Invest® so that you lay the groundwork for your financial plans sooner rather than later. With a SoFi online brokerage account, you can trade stocks and ETFs with no commissions for as little as $5. Then you could be better positioned to take advantage of new opportunities if and when another recession comes along.
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