Wealth Management Strategies in a Recession
During a recession or economic downturn, deciding where to invest your money can be both challenging and stressful. Some investments, such as stocks, can be a bit risky in a down market. If you follow these basic and timeless strategies, then you may be able to get steady returns in a downturn.
- Investing during a recession or economic downturn can be a bit challenging as the equity market tends to drop slightly during a recession.
- If you take a long-term perspective on the market, it can be of great help to you to get out of a downtrend in the market.
- Dollar-cost averaging involves investing the same dollar amount, no matter whether the market is moving up or down so that you can get the lowest average cost.
- Understanding your risk appetite and time frame helps you to keep cash aside for your short-term needs and invest the rest for the long term.
How To Invest During a Recession
Investing during a recession or economic downturn allows you to attempt to time the market. But the best way to effectively manage your money in a recession can depend on a number of factors, including your risk tolerance and time horizon in a recession, which means you don’t need access to the money for as long as you want.
Dollar-Cost Averaging (DCA)
Whether you’re contributing to your regular 401(k) or Individual Retirement Account (IRA) or investing in a non-retirement account through your broker, it’s wise to continue doing so during a recession or economic downturn. It might be possible
Doing so during a recession or economic downturn, the dollar-cost averaging strategy allows you to invest the same dollar amount consistently, regardless of whether the market is going up or down. As a result, you will buy more shares of the stock when the stock price is low and fewer shares when the price is high.
The table below shows an example of an investor buying $1,000 of stock each quarter for one year.
Example of Dollar Cost Averaging
|Stock Price||Invested Amount||Number of Shares|
From the table above, we can see that your investor bought more shares when the share price fell, even though the same amount was invested each quarter. Here are the investment results.
- Total amount invested = $4,000
- Total number of shares bought = 99
- Average share price = $46.25 or ($50 + $70 + $40 + $25 = $185) and $185 ÷ 4 = $46.25
The average price paid for a stock is lower than the opening price due to a down market during a recession or economic downturn. Therefore, if the stock returns to $50, the investor would have a profit of $3.75 or 8% or ($50-$46.25) = $3.75 and ($3.75 x 100 = 8%).
As a result, averaging your dollar costs can boost returns in the long run if the market corrects.
Rebalance Your Portfolio
You can change the balance of your holdings whenever you see a drop in prices. You then rebalance your holdings or return your asset allocation to its original goals.
For example, if your target is the remaining 60% stocks and 40% bonds, your stock share will decrease in a recession while your bond share will increase when the stock market goes down.
- Stock portfolio value: $6,000 (60% of your portfolio)
- Bond portfolio value: $4,000 (40% of your portfolio)
The stock market declines while the bond market rises, changing your allocation to the following
- Stock portfolio value: $4,500 (45% of your portfolio)
- Bond portfolio value: $5,500 (55% of your portfolio)
To rebalance, if you sold $1,500 of your bond portfolio and added that amount to your equity portfolio, that would bring your portfolio back to $6,000 in equities and $4,000 in bonds. When you rebalance during an expansionary phase, you would sell bonds and buy stocks to return to your target allocation.
Always Keep a Long-Term View
If you are purchasing stocks or stock mutual funds for yourself, you will not be required to withdraw funds from your account(s) for at least five to ten years. For this reason, you should not worry too much about short-term market changes.
However, if you need to access the funds soon, such as to pay for your child’s college tuition in the next year or two, you must allocate enough money in bonds or cash until the first year of college. In other words, you don’t want to withdraw money from your equity portfolio when the stock market is down as it can drain your savings.
Keeping money aside for the first few years of retirement, college, or an emergency fund can provide you with cash when you need it, which helps you a lot in dealing with market volatility.
Don’t Discard Your Strategy During a Recession
If stock prices are down, however, that doesn’t mean you need to change the way you invest. Retirement investors, short-term investors, and long-term investors can all use this way of thinking.
Important: A recession is not declared until after several factors have been analyzed. If you plan to sell just before a hit, you are more likely to miss it and lose money.
If you’re adding money regularly to a long-term account like a 401(k) or IRA, don’t stop during a recession or economic downturn. And if you keep most of your money in stocks, then “you don’t chase performance” and sell out of them. They may be falling in price while the price of the bond is rising. If that’s the case, you could be losing more money than you can make in the shares. If you have chosen your stocks and funds carefully, you will end up with more than you started with. Stay the course.
Short-Term Investors and Retirees
If you can be uncomfortable during a bear market, don’t be tempted to sell your stocks or stock mutual funds at a loss. If you need immediate income, it would be best to keep the money separate in cash and bonds before a recession. This way, you can withdraw your cash while waiting for the stock prices to recover.
Take on as Much Risk as Your Tolerance Allows
If you want to make good use of market corrections during a recession or economic downturn, try not to buy more stocks than you would during better times. But if your risk tolerance allows you to accept a moderate asset allocation of 65% stocks and 35% bonds, then you should maintain that target no matter what the market is doing.
Investing Before and During a Recession
It’s easy to go wrong during a recession if you forget or don’t understand how certain investments perform during a recession and how they relate.
Impotant: The stock market looks ahead; the economic report is a review of the past.
Stock prices often fall months before a recession or economic downturn begins, which also means they often bounce back before a recession is declared. If you only follow the news, you could miss out on a complete recession. This is why it is important to know the bearish and recovery signals and how the asset performed during that period:
- Stocks: Stock prices tend to fall before a recession or economic downturn begins and almost always before a recession occurs. If you are trying to take advantage of lower prices, you are most likely to make gains if you buy before the recession begins or during its early phase. And in addition, stocks that pay a cash dividend can provide income, which can go a long way in offsetting some of the market losses in your portfolio.
- Bonds: Bond prices rise during a recession or economic downturn. And the Federal Reserve (Fed) stimulates the economy by lowering interest rates and buying Treasury bonds.
- Cash/Deposit Accounts: Since interest rates often fall due to Fed actions, so do deposit accounts. But unlike bonds and stocks, cash and insured accounts are free from market risk.
- Real Estate: Home prices tend to rise slightly whenever the economy is growing and decline during recessions. And, owning a rental property can allow owners to have a steady monthly income from tenants even in periods of recession. If the real estate market could collapse, as it did during the financial crises of 2007 and 2008 and the resulting Great Recession,
- Gold: Most investors see gold as a haven. Whenever the market goes down, the price of gold often goes up. And when the stock market is looking up, then investors start buying stocks again and sell their gold slowly. This brings down the gold prices again in another massive sell-off.
Tip: Market timing is when most investors try to pick the lowest or even lowest price for a stock with the goal of outperforming the overall market. But some studies have shown that while it’s not perfectly timed, and timing the market doesn’t work, dollar-cost averaging is a better long-term strategy.
Risks vs. Gains of Investing in a Recession
Stocks, or stock mutual funds and ETFs, are slightly riskier during periods of high expansion. They are often even higher during recessions. And it helps some compare the benefits and risks of buying stocks during a recession.
Much before and early in a recession, stock prices often drop somewhat, making this a good time to buy the stock. If you’re the one who continues to do dollar-cost averaging in your 401(k) plan, IRA, or other investment accounts, buying as stock prices decline pays off in the long run.
It is more risky to try to buy whenever the market is open and prices are beginning to turn lower or correct. And you can still face a lot of volatility even if the market has fully recovered. It is often referred to as the “bear market trap”. And you can get caught up in the bear market trap optimism of the moment, only to see another drop in prices followed by a short-term rise.
The Bottom Line
Few investments have performed similarly during similar downturns in history so far. But, no one in the world can predict what will happen in the market in the near future. Stock prices can make a big drop one month, then rise again the next, only to fall again a month later.
Because no one in the world can predict what the stock market will do and how people will react in the short term, it is wise to commit to your investment strategy during a market downturn so that you can participate well in the recovery.
Frequently Asked Questions (FAQs)
How Should I Invest During a Recession / What to Buy Before a Recession?
Taking a longer-term view can help you avoid bear markets. Strategies such as dollar-cost averaging always involve investing the same dollar amount, regardless of whether the market is rising or falling. As a result, you lower your average cost, and you’ll make a lot more in the long run when the economy and market improve.
What Should I Buy in a Recession?
You can always find it helpful to buy stocks for the long term, especially those that pay cash dividends. And besides, bonds can also provide some degree of security, but real estate can also provide rental income.
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