What You Need to Know About Investing During a Recession
Although the S&P 500 has historically returned roughly 10% annually over the last century, the markets rarely move in a straight line. In fact, despite the long term trends there have been plenty of down years (and decades) sprinkled throughout. And it’s these economic recession periods that test the mettle of all investors.
Investing during a recession can be tough, and stressful, but you’ll find that the landscape provides some of the best opportunities to make money.
To not only survive but thrive during a recession, it’s important to invest in companies that have low debt, good cash flow, and strong balance sheets. Ideally, you’ll invest in companies that are in industries that have a history of faring well during tough economic times.
What is a recession?
An economic recession is marked when the economy experiences contracts during at least two consecutive quarters. There are many different factors that can cause a recession, including low consumer confidence, high interest rates, and stagnant wages. World events can also have sweeping effects on the economy.
Since 1854, the United States has had 33 recessions, occurring about every five years. While we’ve made it through them before, history doesn’t make modern recessions any less worrisome. But even under dark looming clouds, there are plenty of silver linings, especially for investors. Making smart investments during a recession can make economic dips much more bearable.
Assets to avoid in a recession
As an investor, it’s critical to know not only which assets to embrace during a recession. It’s even more important to know which ones to avoid. You don’t want to sink your money into investments that will only result in losses.
As a rule of thumb, during an economic downturn, avoid companies and assets that are cyclical, speculative, and/or highly leveraged. Don’t invest in companies that:
- Have large debt loads
- May face a credit crunch
- Have a decrease in revenue
- Involve discretionary expenses (ie. travel, leisure activities, restaurants, etc.)
Steering clear of these assets greatly minimizes the risk of significant losses.
Navigating a recession
When done right, investing during a recession can net you all sorts of gains. Here are some of the top strategies to consider during an economic downturn.
Hang on tight: When a recession hits, you can all but guarantee that stocks will underperform, especially in the near term. And while it may seem like a good time to sell most or all of the stocks in your portfolio, you’ll likely be selling at a loss.
If you’re stressed over the daily (sometimes hourly!) fluctuations of the stock market, consider dialing back your exposure. This is a telltale sign that your portfolio is too stock-heavy.
Instead of selling, hold. History has shown that investors who hold onto their stocks or buy the dip, come out ahead.
Increase your cash position: Want to make a defensive move during a recession? Increase your cash position. Cash is king and it provides not only flexibility but peace of mind. When times get tough, there’s nothing more soothing than cash in hand.
Over the short term, the U.S. dollar is the closest zero-risk asset that you’ll find. However, be aware that the longer you hold onto cash, the lower its buying power becomes.
Buy consumer staples: Almost every stock is at risk during a recession. And the stocks that don’t lose money are at risk of multiple compression. However, there are some stocks that are relatively shielded from economic downturns.
Historically, consumer staple stocks are solid investments to make during a recession. During a downturn, people are spending less on the “nice-to-haves” and instead focusing on the necessities.
Recession or no recession, people will still be buying toilet paper, trash bags, soap, and shampoo. Invest in companies, such as Walmart and Amazon, that sell these products at low prices.
Buy utilities: Aside from staple consumer goods, another good buy during a recession are utilities. Even in a worst-case scenario, consumers will do whatever it takes to keep water flowing and the lights on in their homes.
Because utility rates are set or limited by regulations, their pricing and margin remains relatively stable, even during a recession. Utility stocks also tend to trade at low multiple earnings, which provides valuation protection.
These stocks are also known for high dividends and can generate income, even when the economy is in a slump.
Buy dividend stocks: Dividend stocks have also been historically good income makers during recessions. However, investors need to watch out for dividend cuts. When investing in dividend stocks, choose ones that offer:
- Stable earnings
- Positive free cash flow
- Low debt levels
- Low payout ratio
Buying the right dividend stocks is not only a safe investment, but one that may provide some earnings.
Avoid impulse buys: It’s not uncommon for the markets to be all over the place, especially during a recession. With stocks going up and down every other day, many investors fall into the trap of making buy and sell orders out of fear or greed. But such impulse buys rarely perform well over the long term.
To avoid impulse trades, create a watchlist of stocks that you may be interested in buying. With a watch list, you can track performance of each stock. Analyzing a stock days or weeks in advance of buying it provides the information and trends you need to make sound investing decisions.
While certain investments have followed a similar path during recessions in the past, there’s no guarantee that they will continue down the same road. Recessions are known for causing stock prices to dip and then skyrocket, only to drop again.
As an investor, the best thing you can do is to have a sound investment strategy when times are good. When a recession creeps on, stick through it and find money-making opportunities.