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If you're interested in understanding how to invest during a recession, you may want to first consider your own investment goals, then consider how to take advantage of economic conditions. While trying to time the market is not easy during periods of recession, there are some time-tested strategies that could help protect your portfolio — or even enable you to profit — from an economic downturn. Here's what to know.
How Recessions Can Impact Investments
Whether you are a long-term investor, a retired investor or someone who wants to learn how to start investing, it's important to keep in mind some general trends on how recessions impact investments:
- Falling stock prices (before and during recession): A bear market for stocks, which is a decline of at least 20% from a recent high, usually accompanies a recession, especially the early phases.
- Stock market recovery (during and after recession): Monetary and fiscal stimulus, even in the depths of a recession, can be the catalyst for a market move upward. For example, the worst of the coronavirus bear market occurred from late February to late March 2020, when stocks fell by nearly 35%. On March 27, the government announced the CARES Act, and stocks began their rise upward. By the end of 2020, the S&P 500 Index had climbed more than 40%.
- High quality bonds rising in price: Once the Federal Reserve begins to lower interest rates, the higher rates offered by existing bonds will typically look more attractive to investors. This demand for older, higher-quality bonds tends to push their prices higher. Lower quality bonds, also called "junk bonds," tend to fall in price during recession because of the increased risk of bankruptcy of the issuing entities.
How to Invest During a Recession
The strategy for investing during a recession will not be the same for every investor. Some may continue to buy and hold the same investments; some may get more aggressive and actively buy as the market falls; others may make a few defensive moves to help protect their portfolio from market volatility. Just keep in mind that investments cannot guarantee growth or sustainment of principal value, and they may lose value over time. Past performance is not an indication of future results.
Here are various considerations on how to invest during a recession:
- Diversify holdings: Spreading your risk across asset classes — such as stocks, bonds and cash — may help to reduce downside risk while taking advantage of upside potential when the market comes back. Within each asset class, you can further diversify with different types of stocks and bonds or mutual funds. However, diversification cannot guarantee profit or protection against loss in a declining market.
- Consider defensive sectors: During times of recession, consumers still tend to buy necessities, such as medicine, food and personal hygiene products. To get defensive and diversify your holdings, you might consider stocks or stock mutual funds from defensive sectors, such as healthcare or consumer staples.
- Hold high quality stocks: Dividend equity and large-cap stocks often maintain price stability better than aggressive growth stocks.
- Hold high quality bonds: Since interest rates and bond prices generally move in opposite directions, bonds and bond mutual funds can be smart holdings during a recession. Bonds with above-average credit quality tend to maintain price stability more than the lower-credit quality junk bonds.
- Dollar-cost averaging (DCA): When you follow a DCA approach, you are buying shares of investments on a periodic basis, such as monthly. This way, you are buying in all market environments, whether the stock market is up or down. Over time, you may "average" the lower price of your investments, which may help them to grow faster over time compared with just buying during prosperous economic times. DCA does not assure a profit or protect against a loss in declining markets. You should consider your financial ability to continue your purchases through periods of low price levels.
- Increase contributions: If you are fortunate enough to be in good financial health, consider increasing contributions to investment accounts and retirement accounts to take advantage of lower prices.
- Rebalance portfolio: Rebalancing reallocates your portfolio to your original target allocation. For example, if your target allocation is 70% stocks and 30% bonds, and market conditions have changed your balances to 60% stocks and 40% bonds, rebalancing will buy stocks and sell bonds to get back to the 70/30 target.
Potential Risks & Benefits of Investing During a Recession
Higher risk generally translates to higher potential returns in the long run. However, investors should take note of the pronounced risks and benefits of investing during a recession:
- Potential risks of investing during recession: Stock prices can fall as much as 20% or more during a recession. Somewhat ironically, this market risk can be increased by selling out of your stock positions in the middle of a bear market. Keep in mind that being out of the market when stock prices begin to recover will also limit future returns.
- Potential benefits of investing during a recession: For long-term investors, the primary benefit of investing during a recession is buying more shares of long-term holdings, such as stocks, at depressed prices. A recession-induced bear market creates a "sale" for stocks and can sometimes be the best time to buy.
Recessionary periods can be a good time for long-term investors — as well as those learning how to start investing — because there are generally more opportunities to buy at lower prices. But some investors, especially those in or near retirement, might have unique circumstances that may require a more cautious approach.
Because there is no one-size-fits-all approach to investing during a recession, investors may want to seek the guidance of a financial professional to find strategies that fit their unique needs.