Welcome back to the Smart Money Club recession investing series; in our last lesson (CLICK HERE), we answered whether or not you should invest during a recession. In this lesson, we will be taking you to the Power of X, teaching how you should invest before and during a recession.
Investing Before and During a Recession
Recessions are a mental strain on investing. If you don’t understand or forget how certain investments react and how they relate during bearish markets, your long-term performance can be affected.
The stock market is forward-looking. The prices of stocks reflect what investors believe about the company’s future when taking into account all the available information. Economic reports like inflation and unemployment, or financial performance, such as a company’s quarterly results, are backward-looking.
Stocks will often fall months before the beginning of a recession, and they will also rebound prior to a recession being declared over. An investor can fail to recognize the signs of a downturn by only following the news. This oversite is why knowing the indicators of a recession and a recovery is vital. You will want to add to this knowledge familiarity with how assets perform during these signaling periods.
Stock prices will tend to fall before a downturn begins, and they are almost always sure to fall before a recession is identified. If you are looking for deals on stocks, then you are most likely to benefit buying before the recession is called or during its early phase, when most price decreases have already been factored in.
Bond prices will generally rise during a recession. This is because the U.S. Federal Reserve (the Fed) will try to stimulate the economy with interest rate reductions and purchasing Treasury bonds.
Cash and Deposits accounts are free from market risk, and the FDIC insures them to $250,000, but these assets are more susceptible to inflation. While cash and deposit accounts’ values are not lost during a recession, their purchasing power is reduced if there is inflation. Since interest rates on these accounts fall with the Fed’s actions, the returns of money market or savings accounts will fall.
Precious metals like gold and silver are are considered a safe haven for investors during a recession. The price of gold will often rise as the stock markets fall. As the economy takes a turn for the better, investors will begin to sell their gold and put their money back in the stock market. This will have new downward pressure on gold’s price, and usually, gold’s price will fall from another sell-off. Gold is a Store of Value (SoV), an asset used to stave off the effects of inflation.
The Risks and Gains of Recession Investing
The risk of investing in stocks, stock-based mutual funds, and Exchange-Traded funds (ETFs) is omnipresent; however, their risk increases during a recession. It is beneficial to compare the positives and negatives of investing in equities (stocks) during a recession.
Positives– Before and at the early stage of a recession, stock prices will often fall. After this initial fall is a good time to be buying. If you are a consistent investor, taking a portion of your monthly income and investing it in a tax-advantaged account usually a 401(k) or an IRA, or into a general investment account, the opportunity of buying the stocks as prices are falling will pay off in the long run.
Negatives- Attempting to “time the market” and buy when prices are at their low or are just beginning to recover is rarely successful and is a significant risk. You can still be the victim of severe volatility; even when the market seems to have recovered, it may drop again or a third time. This instance is referred to as a “bear market trap.” Many investors will get caught up in the hopefulness of an upward turn only to get crushed by an additional fall in prices when other investors take profits on the short-term gain.
Summary
History has shown that there are certain investments that perform in predictable ways during recessions. That said, no one can consistently predict how a market will perform in the near term. With recessions, the stock market can have a significant loss one month; the next month, it will recover, only to fall again in the following month. Because no one can predict how people will react to movements in the stock market in the short term, a smart strategy is to invest consistently during a market downturn; the same strategy is used when markets are climbing or flat, with down markets investing this way, ensures you participate in the recovery.
Did you miss Part 1 of this series? If so, click here to get caught up.
