The stock market works cyclically. After every boom, there is bound to be a downturn sometime. With the global conflict caused due to the Russia and Ukraine war, it is imminent that financial markets will be impacted. The demand and supply have already been disrupted, and economists are predicting a recession in the coming year. All of these things can be of great concern for all investors.
A recession can be cruel in many ways. It can lead to job loss, low returns, and extreme financial and mental stress. However, it is unavoidable. The stock market goes through a recession as part of the business cycle. A business cycle contains six phases – expansion, peak, recession, depression, trough, and recovery. Expansion is the beginning of the business cycle where demand and supply are high, employment is booming, and investments, salaries, and wages are rising. Peak is the top of the cycle and witnesses the maximum economic growth. Income is high, but so are the prices. This is followed by a recession where demand and supply lower and prices drop. The next phase is a depression where economic growth is the lowest and unemployment is at a high. Depression ends when the economy enters a trough. The trough marks the stagnation in unemployment and prices. Finally, recovery brings the economy back up.
Each of these phases can impact your investment portfolio differently. To learn how you can safeguard your investments during recession, reach out to a professional financial advisor who can advise you on the same.
For now, since a recession is the primary concern of the hour, here are some things to know about it and how to prepare for a recession:
What is a recession?
A recession is a phase in the business cycle where the market sees negative economic growth for at least two consecutive quarters. It can last for six to 18 months, depending on several factors. If the Federal Reserve and the government are able to take the proper measures, the period can be shortened. A recession is usually measured with respect to the Gross Domestic Product (GDP). One of the most famous instances of recession ever has been the financial crisis of 2008, which saw job loss and unemployment on an enormous scale globally.
It is also common for stock prices to fall during the recession, which evidently leads to investment loss and low portfolio values. Investors invest less in the market out of fear which further leads to less money in the economy and a drop in demand and supply. Businesses are impacted, which is why a lot of employees are laid off. However, inflation lowers in a recession which can be a respite for people.
Where should I invest my money during a recession?
A recession can be tricky to navigate through. Here are some things to know about investing in a recession that can help you protect your wealth and minimize the ill effects of an economic downturn.
1. Invest for the long-term:
Fear in investing is never advised, and more so in a recession. The falling stock prices and slumping investment portfolios can trigger many investors. This usually leads to panic selling. However, it is essential to maintain a long-term outlook. One of the best advantages of a long-term investment plan is the opportunity to ride out market volatility. Having a long-term approach can help your money grow and benefit from the changing market dynamics. As mentioned above, the market works in cycles. One business phase is followed by another. So, if you are in the middle of an investment slump, it can soon recover as the market gets back on its feet. If you start selling your investments in a panic, you take away the opportunity from them to recover. Moreover, your money is not lost until you withdraw it. There is a difference between falling figures on a piece of paper or screen and your actual account balance in the bank. Your losses are not realized till the moment you sell your investments and redeem them in cash. If you maintain your cool and let your investments be, your losses are only superficial. When the stock prices bounce back, so will your investments. When the time finally comes to redeem them in the future, you could have earned profits that can balance out the short-term loss caused by the recession.
2. Consider investing in bonds:
A well-diversified portfolio with an adequately planned asset allocation of stocks and bonds can be ideal in most market conditions. Stocks are susceptible to fluctuations with changing market dynamics. However, bonds might bring in more stability to your portfolio. The Federal Reserve often buys U.S. Treasury bonds to stimulate the economy and lower interest rates. When economists expect a recession, investors generally shift to bonds. This results in a fall in stock prices and a rise in bond prices. When the interest rates increase, the price of bonds falls, and vice versa.
U.S. Treasury bonds could be a safe haven in recession. They have no credit or default risk as they are backed by the federal government. Municipal bonds can be another option. The state and local governments issue municipal bonds. They can be a relatively high-risk option to U.S. Treasury bonds but still low risk than other options like stocks. Money market accounts are also an option for investing in a recession. These carry low risk and deliver low returns. However, they can be suitable for the short term, and you can invest in them for the duration of the recession.
3. Invest in specific types of stocks:
Not all stocks plummet during the recession. Some companies can stand the test of time and provide stable returns during market downturns too. For instance, large-cap funds can be more durable than small-cap funds. This is primarily because large-cap companies have the biggest market capitalization. These businesses are well-established and can withstand market highs and lows without being severely impacted. These funds can save your portfolio from dropping compared to small and mid-cap funds. If you have small-cap funds in your portfolio, a recession can be an excellent time to shift to large-cap, blue-chip funds. You can also consider investing in utilities-based mutual funds. These mutual funds invest in consumer staples like food, hygiene products, beverages, household products, etc. Since these products are always in demand and fall into the category of essential products, they are less volatile and can deliver steady returns.
High-net-worth individuals can also consider hedge funds for investing in a recession. Hedge funds are actively managed funds that require a relatively high investment value, which is why they may not be ideal for average investors. However, they can be suitable for wealthy individuals. These funds trade esoteric assets with borrowed money and aim to offer higher than the average rate of return. They can be a good alternative investment but also carry very high risk. However, strategies used by hedge fund managers aim to generate returns across market conditions, including declines like a recession.
How to protect your money during a recession
Along with knowing how to prepare for a recession with suitable investments, it is also essential to understand what not to do to protect your money.
1. Taking on debt:
When your investments show a downward trend and the likelihood of earning a bonus seems bleak, taking on debt can be one of the first things many people resort to. However, adding debt to your liabilities in a recession can be a bad idea. Debt creates an additional financial burden that can be hard to pay off. Moreover, since there is no job security in a recession, you may struggle to pay off your loans if you happen to lose your job.
2. Investing in certain high-risk stocks:
A recession may not be the right time to add risk to your portfolio. A recession is burdensome on individuals and companies. Many companies are forced to shut down due to shortages. So, company stocks can be highly volatile. While some stocks may offer some leverage against inflation, spotting these can require experience and knowledge of the market. Day trading may also not be advised as the stakes involved can be high. A lot of investors end up buying and selling stocks without any understanding of the market. However, this can lead to significant losses depending on how much you invest.
3. Avoid panic selling:
Investment decisions made out of emotions like fear, anxiety, or stress can often lead to irreparable damage. As mentioned above, keeping a long-term approach to investing can be ideal in a situation like a recession.
4. Create a budget and watch your expenses:
In a situation when you may lose your job or receive a salary cut, it can be essential to make sure that you are mindful of your expenses and do not exceed your budget. Adding more financial burdens with mindless spending can be problematic with you already dealing with so many financial issues around you.
A recession is a normal part of the business cycle. The market will go through all the phases at some point, and your investments will go through ups and downs because of it. So, you do not necessarily have to fear it. Instead, you can prepare for it properly so that you are not caught off guard. The last recession of 2008 was an isolated event that affected the world significantly. However, not all recessions are that extreme. Typically, an optimally diversified portfolio can help you deal with the effects of the recession and protect your money.
However, if you need more streamlined advice on how to prepare for a recession, you can reach out to a professional financial advisor in your area. Use Paladin Registry’s free advisor match tool and get matched with 1-3 qualified advisors who may be able to help you with your unique financial goals and requirements.
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