What Happens During A Recession?
Recessions can last a few months. In every past recession, there were job losses, market drops, and other events that tested investor patience. According to National Bureau of Economic Research (NBER), the body that decides when the U.S. economy is in a recession or expansion, “expansion is the normal state of the economy” and that most recessions are brief. That means, the markets and the economy eventually stabilize after a recession, usually followed by much longer expansion. But most investors underperform the market. This is even more true during downturns. They may lose more money during those downturns and make less money when the markets recover. That usually occurs when fearful investors sell stocks in a falling market, and lose out on any potential gains when the markets recover. While its never a good idea to try and time the markets, investors can employ certain investing strategies to insulate their portfolio against downturns.
Invest According to Your Risk Tolerance
How you invest your money during a recession (or any other time) should align with your risk tolerance and determine your investing style—whether you take a more aggressive or conservative approach. Investors who opt for the aggressive approach value growth; they understand volatility and accept it. They may be willing to take on risk. They may not be concerned about liquidity. On the other hand, those who are more conservative value principal or capital preservation, and may accept lower returns. For example, an aggressive investor may allocate more to U.S. and foreign stocks. But a conservative investor may have a larger allocation to bonds and short-term investments.
Stay the Course
While painful in the short term, patience during recessions usually earn long-term rewards. Strategic investing can help you stay the course. This is a long-term approach with a time frame of 10 or more years. It’s often used to fund retirement or education expenses down the road. With this approach, you systematically plan to allocate money to different asset classes depending on your risk tolerance. These assets may be stocks, bonds, real estate, and more. Models are billed as aggressive, moderate, or conservative. For instance, an “aggressive” model might have 80% stocks and 20% bonds; a conservative model might have 20% stocks and 80% bonds. “Understand volatility and don’t sell low at the bottom,” Wendy Liebowitz, branch leader of the Fidelity Investor Center of Fort Lauderdale, told The Balance via email. “You need to have a certain amount of tolerance to stay through your planned time frame.” If you’re just getting started with investing, don’t worry about when to get started. This is true even if we’re in a recession. Whether the market has just hit fresh highs as it did in August of this year, or the market is at a dismal low like it was in March, research shows that it doesn’t matter when you enter the market. What’s more important is that you invest systematically over time. “Identify your approach and criteria and adhere to it,” Leibowitz said.
Rebalance or Diversify Your Portfolio
To keep your portfolio on track, you may need to rebalance. In other words, you might need to sell one type of investment to buy another type. Let’s say your plan calls for 50% stocks and 50% bonds. But the stock values increased more than the value of the bonds in the past year. That put your portfolio at 70% stocks and 30% bonds. In this case, you could sell stocks to buy more bonds to rebalance your portfolio to bring the mix back to 50-50. Also, your goals may change. Or, you might find out you’re not the risk-taker you thought you were. You could add bonds to create a more conservative portfolio model. If you find you’re able to handle more volatility and risk, you could add stocks.
Look into Tactical Investing
Let’s say your longer-term investment plan calls for maintaining 60% stocks and 40% bonds. But you can still change your portfolio to take advantage of opportunities or decrease your risk. In contrast to strategic investing, tactical investing responds to the market. Consider this method based on the business cycle framework. The business cycle has four phases: expansion, peak, recession, and recovery. Some sectors perform better than others during different parts of the business cycle. In the midst of a recession, consumer staples (such as food and clothing), health care, and utility stocks tend to be strongest. During the recovery phase, real estate, consumer discretionary, and industrial sector stocks often outperform other sectors. Aggressive investors might buy stocks in sectors like consumer discretionary. These are goods that people want but don’t need, such as TVs and vacations; they trade below their fair value during a recession because they’re a bargain. These investors are willing to wait for growth until the recovery begins. On the other hand, less aggressive investors could add stocks that pay dividends. This can help soften the blow of other stock price declines.
Use Dollar-Cost Averaging
Regular contributors to a retirement plan like a 401(k) could consider dollar-cost averaging. This is when you contribute the same amount of money per pay period to each stock, ETF, or mutual fund that you’ve chosen in advance. When share prices are down, you’ll end up buying more shares. When share prices are up, you’ll be buying fewer shares. The best part? No need to second-guess when the market will be up or down. Over time, the price of the shares will average out.
Build Cash Reserves
If you’re new to investing, first set up a cash reserve or an emergency fund. Your cash reserve should be three to six months of your salary. If you need cash for any reason during a recession, you won’t be forced to sell investments to meet the need. Over time, your investments can grow. And your cash reserve could allow you to take advantage of market opportunities in the future.
