What to Invest in During a Recession
High inflation, rising interest rates and worrying developments in the banking industry have increased concerns about a recession in 2023.
A recession refers to a period of negative economic growth, which can have undesirable knock-on impacts on a variety of areas, particularly in the stock market. So, should you invest in a recession? In this article, we examine this question, weighing the case for and against, and assess what to invest in during a recession.
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Should You Invest in a Recession?
A recession is typically characterised by two consecutive quarters of negative economic growth. But, aside from a contraction in the size of economy, a downturn is typically accompanied by several other negative occurrences.
As the economy contracts, consumption tends to fall and many businesses will consequently report lacklustre or poor earnings. This will tend to lead to negative sentiment amongst investors, with many panicking and selling their shareholdings. An increase in selling activity can spark widespread selloffs and lead to a general decline in stock market values.
Furthermore, as businesses generate less revenue, management look for ways to cut costs. Consequently, job losses can become more prevalent, leading to an increase in unemployment, which reinforces the overall effect by causing consumption to fall further.
Taking this into account begs the question, should you invest in a recession? Or would you be better off leaving your money in the bank? The answer to these questions is not so straight forward and will largely depend on your individual circumstances.
What to Consider Before Investing During a Recession
A falling stock market can be bad news for existing portfolios, but the lower share prices can, in theory, provide the opportunists amongst us with the possibility to buy shares at a lower rate.
However, as well as being risky, this approach to investing during a recession will not be suitable for everyone and there are a couple of important factors to consider before investing.
Recession or not, it is always recommendable to have an easily accessible emergency fund to cover your necessary expenditure in the event of the unexpected.
Due to the inherent risks involved with investing, creating emergency savings should be your first priority before you consider starting to invest. Again, this is true whether there is a recession or not, but having an emergency fund becomes even more important during an economic downturn.
A Long-Term Mindset
Similar to our previous point, this is actually true of investing in general, but it takes on increased significance during a recession.
You shouldn’t invest any money that you are going to need in the next five to ten years. Due to the volatility of the stock market, it’s entirely possible that in the short-term your investments will fall in value, meaning that you need to allow sufficient time for your investment to be able grow.
This is particularly true in a recession. It is incredibly difficult for investors to accurately time the market, meaning that, if investing during a recession, it is very unlikely you will enter at the bottom of the market.
Your investments may fall in value as soon as you make them, which can take its toll psychologically. You should be prepared for this eventuality and only invest if you are willing, and able, to give your investments enough time to potentially recover and grow.
What to Invest in During a Recession
Whilst the knee-jerk reaction of the stock market to a recession may sometimes be more severe than the economic downturn in question actually warrants, it is not the case that every company will necessarily recover.
Smaller, younger companies and companies with weak balance sheets often go out of business during an economic downturn, as they do not have, or are unable to generate, sufficient capital to weather the storm.
Just because a stock has fallen in price and now appears cheap, it doesn’t necessarily mean it offers investors good value. More often than not, cheap stocks are cheap for a reason.
Therefore, don’t forget to do your due diligence. Only invest in quality companies which have a strong balance sheet and are likely to be able to survive a downturn and thrive on the other side. A recession is not a good time to take unnecessary risks with your money.
So, what should you look out for in particular when looking where to invest in a recession? Well-established, cash-rich companies, which have a significant competitive advantage in their industry will be comparatively well-positioned to survive a prolonged downturn.
However, remember that, whilst some companies may be better positioned to survive a recession than others, none will categorically be safe. Investing is risky at the best of times, but during a recession this risk increases significantly.
Although there may be an argument for investing during a recession to pick up cheap stocks, perhaps the more reliable approach to investing over the long-term is to invest regularly, regardless of what is happening in the wider economy.
Dollar-cost averaging is a popular and potentially effective way of investing over the long-term. It involves investing a fixed amount of money at regular intervals as opposed to investing a large sum of money at once.
By investing regularly in this manner, investors can smooth out short-term price fluctuations and avoid the risks involved in timing the market. Some months investors will pay more for their chosen asset, others less, but over time the prices will average out and, in theory, should increase the chances of paying less per unit in the long-term.
What Not to Do During a Recession
Those with existing investment portfolios should avoid panicking. A common reaction to a falling stock market is for investors to liquidate their shareholdings out of fear. This is rarely a good idea and is certainly not a decision that should be taken spontaneously.
By selling off your holdings, you are locking in your losses and eliminating the possibility of a recovery further down the road.
It’s important to bear in mind that recessions are a normal and unavoidable part of the economic cycle, albeit an unpleasant one. Consequently, investors should make sure to factor potential recessions into their overall investment strategy. By doing so, you can avoid unnecessarily panicking by preparing yourself for how best to react when the inevitable happens.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.