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As the economic impacts of Coronavirus wear on, many are left wondering how to invest during a recession. Candidly, I am writing this post after reading lots of bad advice from so-called “experts” about how to invest during a recession. Many will tell you to start picking strategies around companies that do well in a recession or to choose specific stock sectors. That is a short-sighted view and one that is bound to lead to underperformance. In this guide on how to invest during a recession, I will share the exact approach I am taking in navigating the latest economic crisis. This approach works for this recession, and it will work for all future recessions – my approach is nothing if not consistent.
What is a Recession?
If you’ve landed here, you probably have some sense of what a recession means. However, I want to make sure you grasp what a recession technically means, rather than how it’s advertised in the media.
Historically, a recession has been defined by two consecutive quarters of declining gross domestic product (GDP) in conjunction with a rise in unemployment. While that definition continues to evolve, a recession does not mean that the sky is falling. It just means the economy has hit a speedbump, and many people may be negatively impacted economically for some time.
While everyone’s situation in a recession is a bit different, I am going to cover how to invest during a recession if you’re in a financially stable position as well as what to do if you have a bit more uncertainty.
Stay the Course
First and foremost, I want you to stay the course. Assuming you have a defined investing strategy (portfolio allocation of stocks, bonds, etc.), I want you to stick with it. If you don’t yet have a defined investing strategy, now is an excellent time to put a plan in place. While the broader economy and the stock market aren’t always linked, during a recession, it is not uncommon to see the stock market fall in tandem with the economy.
Handling Emotions During a Stock Market Decline
A big part of learning how to invest during a recession is learning how to manage your emotions and not allow them to damage your current portfolio.
I have seen so many people panic when they see the stock market take a nosedive, and they immediately sell. I am pleading with you. Don’t do it. Emotions will undoubtedly be a detriment to your long-term investment performance.
The only time to sell during a recession is if you need the cash to cover your living expenses. I am talking because of dire issues (lost job with no emergency fund type of problems). Don’t sell stock as a preventative measure to boost cash.
Those who make money coming out of recessions are those that hold their positions and BUY MORE.
No one has described this more eloquently than Warren Buffett.
“Be greedy when others are fearful and fearful when others are greedy.”
This is perhaps the aptest advice I can give you for investing in a recession. To be greedy when others are fearful means investing more during a downturn when others are fearful. This is how you make more money investing than the average Joe.
Remember that stocks become less risky when they decrease in price, not more.
Sticking to Your Investment Strategy
Let’s say, for example, that your investment approach is 70% stocks and 30% bonds. I want you to stick with this mix through the recession. Do not change it.
If this is your portfolio mix, and you’re finding yourself stressed out watching the stock market gyrations, this is a clue about your risk tolerance. What I mean by this is that if you find yourself worried about your investments, or the daily stock market moves, that may mean you’ve taken on too much risk in your portfolio.
No one truly knows how they will react when they see their portfolio falling until it happens. While I am asking you to stay the course for the time being, when the world stabilizes, think about whether you should adjust your portfolio allocation based on how well you controlled your emotions during the stock market moves.
Emotions are the enemy of investing results.
Increase Your Cash Position (if necessary)
Next, if you’re staying the course, you may be thinking about investing more. Before you decide to invest further, I want you to consider your current cash position, particularly if you’re in a financially vulnerable state.
Do you have an emergency fund? How many months is it? If your emergency fund is less than six months of expenses, I want you to take this opportunity to beef up your savings. Recessions are a volatile time, and if you think your income is at risk, there is nothing more important than building a cash cushion.
Second, do you have high-interest rate credit card debt? If you have debt that costs more than the long-term historical stock market returns (~7%), pay off this high-interest rate debt before choosing to invest additional funds in the market. You can never out-earn high-interest rate debt, and that’s why it should be a priority.
You may ask why I am advocating your emergency fund before high-interest rate debt.
While there are arguments to be made of an emergency fund before debt vs. debt before emergency fund, in a recession, I want you to prioritize the emergency fund. The reason is that it will help prevent you from adding to the debt mountain in case things turn sour. Of course, pure math says to pay off the debt first, but bear in mind this comes with a bit more risk if you lose your income.
Extra Cash Cushion
Finally, how secure do you feel in your job? If you think that you may lose your job, skip investing, and build a deeper cash cushion, even if you already have a solid six months. It certainly can’t hurt to have more than six months of expenses on hand in case the economy remains suppressed for a more extended period.
Once you have paid off high-interest rate debt and have a substantial emergency fund, it’s time to start boosting your investments.
Increase Your Investments (if possible)
In this section, I am going to discuss how to invest any spare cash during a recession. But first, I want to share how I reacted to the latest stock market dip.
How I Handled the Last Stock Market Implosion
During this recession, when I saw the stock market fall 30% from its highs, I got excited. Yes, you read that right. I was thrilled. Why? Because I saw an opportunity. Stocks went on sale.
In my specific case, I have a long time horizon until retirement, and thus my goal is to acquire as many shares of stock as possible. When stocks fall in price, I can buy more shares. In the long run, acquiring more shares is what will make you wealthy.
In this particular circumstance, I scrounged up a few thousand dollars to invest in the market. While I was already nearly fully-invested, I wanted to take advantage of the opportunity and invest as much as I could.
My view is this: despite what happens in the short-run, I believe in the long-term economy. The short-run does not matter to me. Unless you think the United States is going the way of the Roman empire, keep investing.
Of course, if you are in a different position, such as approaching retirement, a fall in the stock market can have more prominent adverse effects on your portfolio. If you’re nearing retirement, make sure that your portfolio is an appropriate mix of stocks and bonds so that these stock market moves don’t cause you to panic sell. Again, use the fall in stocks as a gut check to help determine if your portfolio allocation is right.
Investing Extra Money During the Crisis
If you have extra money to invest in the market, do it. Of course, this is after you’ve built an emergency fund, paid off high-interest rate debts, etc. A down market is the best possible time to invest.
However, you can’t time the market. Trying to time the market is a fool’s errand. That’s why I stay fully invested at all times.
However, when I saw the recent stock market decline, I knew the opportunity was too good to pass up, and I found some money to invest. I wasn’t trying to time the market – I just saw an opportunity, and I took it by finding extra cash to invest.
Over the long haul, time in the market is much more important than timing the market.
Lump Sum vs. Dollar-Cost Averaging
This particular economic downturn is unusual because it is unclear if the recovery will be long-lasting (pending the end of the Coronavirus pandemic). In this case, you have two choices.
- Put any spare money into the market now in one lump sum.
- Invest a bit of your extra money each month (investing over several months).
From a purely historical perspective, you’re better off doing a lump sum investment rather than spreading your investment over some time. If your money is not in the market when the stock market has its best days, you miss out on a significant chunk of returns.
However, if you want to act a bit more conservatively (thinking things may worsen again), you can invest a set amount over some time. This is called dollar-cost averaging. You will buy some more expensive shares and some less costly shares. You’re not necessarily trying to time the market, but you’re not necessarily 100% committing to time in the market.
For example, if you have $1,000 to invest, you may invest $200/month for five months.
Either approach is acceptable, and to some extent, it depends on how comfortable you are with a lump sum investment.
How to Choose Investments During a Recession
During a recession, my investment selection remains unchanged. I continue to invest in low-cost, diversified index funds.
Some purported experts will say to pick staples that perform well in a recession or to pick individual sectors. This advice stinks. It’s short-sighted. No one knows which investments will perform well over the long-haul, and that’s why I suggest you don’t change your strategy from investing in broad-based index funds. Investing is a long-term game. Treat it as such.
How to Commit to the Strategy
For some of you, committing to your strategy and putting money to work right away may be relatively easy. For many of you, I realize this is not the case – you are looking for a way to stay committed to a strategy. I am going to give you two approaches based on how much you have to invest.
First, if you have a sizeable amount of money to invest, check out M1 Finance and set up automated investing, which will take money from your account every single month to invest. This is dollar-cost averaging at work.
Second, if you don’t have much to invest, check out Acorns, our favorite micro-investing app. Acorns will allow you to invest even with little money. Again, you’re taking advantage of dollar-cost averaging, not trying to time the market but instead investing over the long-haul. However, this is a slower approach, and during a recession, if you can put money to work more aggressively, you stand to reap the long-term rewards.
The world will emerge from this recession. When it does, use the opportunity to prepare for the next recession.
How to Invest During a Recession: A Summary
During a recession, it is easy to let emotions drive your investing strategy. The truth is, however, successful investors turn off these emotions and invest based on a long track record of stock market history. Buy low (during a recession), sell high. Timing the market doesn’t work, so stick to your strategy. The stock market will bounce back – it always does.
If you’re a long way off from retirement, the short-term gyrations are just that – gyrations. Over many years, staying invested and continuing to add to those investments is the key to wealth creation.
Learning how to invest during a recession doesn’t have to be complicated. If you’ve been reading ASF, chances are, you are already doing many of the right things.
Stay the course, keep investing, and you will stand to reap the rewards.
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