A recession generally happens when GDP declines over two or more consecutive quarters.
Many people lose their jobs, businesses can go bankrupt, and the prices of goods and services rise. A recession is a challenging time for most people and markets.
Nonetheless, recessions happen. Take a look at the COVID-19 recession of 2021, the Great Housing Crisis of 2007-2008, and thirteen more since the 1930s.
Considering the reality of a recession and its potentially severe consequences, you may wonder: is it a good idea to invest during a recession? How can you safeguard your finances during one?
Are we in a recession?
The only entity that can officially declare a recession is the National Bureau of Economic Research’s Business Cycle Dating Committee. They look at more data points than just GDP to determine this.
While the above may be true, this does not mean that you can't evaluate on your own when a recession can begin.
These signs do not guarantee that you can accurately predict a recession, but they are can help tell if we are heading into one.
- Rising Inflation
Although a small inflation rate is good, soaring inflation is not, as it increases the cost of living and interest rates. High-interest rates discourage companies from borrowing, expanding, and accepting new hires. This lessens business activities needed for the economy to grow, thus can signify a start of a recession.
- Falling Stock Market Values
The health of the stock market and the economy do not always see eye to eye. There are times when they have the same trajectory (bullish or bearish), and there are others when they are complete opposites.
Nonetheless, it is still important to look at stock prices to indicate what’s to come in the financial markets and their sectors.
The stock market provides a bigger picture of the economy at least six months into the future. A continuous drop in stock market values and returns indicates that investors expect lower profits from certain companies or sectors.
- Rising unemployment
One of the major expenses of businesses is employee wages, so when the market becomes tough, this is the first thing they cut back. Therefore, it makes sense that unemployment rates rise leading up to a recession.
How to prepare for a recession
Confidence comes from being prepared.
If your evaluation convinces you of an impending recession, here are ways to prepare yourself for any economic uncertainty.
- Assess your financial situation and create a monthly budget.
The first step to preparing for a recession is to take a hard look at your finances. In a recession, you want your funds to last as long as possible, so knowing your monthly cash flow can help you identify the best action to secure your financial health.
Creating a monthly budget also helps you establish how much you want to save and spend. It lessens your chances of overspending and pinpoints which expenses you can cut back on or remove.
- Build a solid emergency fund and park it in a high-yield savings account.
Before investing, make sure first to have an emergency fund that covers three to six months' worth of living expenses, with the latter being more ideal. Setting aside funds for an unexpected situation, such as losing your job, or getting hospitalized, is a priority.
If you have extra money after the emergency fund, these are the funds you can invest to get returns.
You want your emergency fund to be liquid and accessible during a recession, so keeping it in a high-yield savings account is recommended. Moreover, it enables your returns to be competitive against inflation.
- Recession-proof your career
During recessions, those who don’t have strong credentials and skill sets are more likely to be laid off. It is then important to strengthen your skills and pursue more training that can make you more attractive in the job market.
Networking and maintaining strong connections with colleagues are also helpful in finding new opportunities.
Is it safe to invest during a recession?
Once you have considered your situation and have done everything at your disposal to prepare, then you may consider investing your extra funds.
The decreasing stock prices during a recession may present a good investment opportunity. It’s actually how Warren Buffett made a lot of his money. By finding undervalued stocks that are foreseen to survive the recession, you’ll effectively increase your potential profits over the long run.
If you don’t invest during a recession, you’ll miss out on the returns of the recovery stage. This is exactly what happened in the middle of the pandemic. The market dropped by 40-50% and smart investors made millions over the next couple of months enjoying the recovery stage.
Just know that not all companies survive a recession. Some companies or sectors may take years to recover from a recession, or some companies may not even recover at all.
This fact increases the anxiety of investing during a recession.
To come out as a winning investor in the middle of a recession, create a clear-cut investment strategy before dipping your hard into the markets.
What to invest in during a recession
Picking what financial instruments to invest in during a recession depends on your personal goals. Do you want to –
- minimize the risk of an investment losing value/returns?
- maximize long-term returns?
- establish a source of passive income return?
- capitalize on cheap prices to get maximum returns?
Choosing an investment strategy and sticking to it can help secure returns and your financial future. Although there are no bulletproof investments, some sectors or financial instruments hold up better or even appreciate during a recession. Let’s take a look at some of your options.
- Companies in Health Care and Consumer Staples
These stocks are considered “defensive stocks”. They weather the economic downturns and produce consistent returns because these companies sell items or provide services everyone buys – no matter the economic situation.
- Companies with Healthy Financial Positions
You may also consider stocks with solid financial ratios - low debt, profitability, positive cash flow, and strong balance sheets. Keeping these characteristics intact helps a company survive difficult times like the recession.
- ETFs or Index funds
Not all people are traders, so if you are uncomfortable investing in individual stocks, you may consider low-cost ETFs or Index funds. They are financial instruments that trade or track a basket of securities under one portfolio and can generate consistent returns.
This is one way to get exposed to several companies during recessions and limit your risk. If one company in the fund does not perform well, other well-performing assets may offset this underperformance.
- Fixed-income Investments and Dividend Stocks
You may also invest in fixed-income securities, such as bonds or dividend stocks, during a recession because they provide regular cash returns. Thus, even if your investment goes down in value, you can reinvest the cash returns and lower the volatility of your portfolio.
- Alternative Investment Options
There’s always that one risk-taker who doesn’t care about stock market conditions. The start of a bear market could easily burn this type of investor – their investments, more volatile than most, are often the first to devalue and crash.
Here’s the thing: when the markets are down and the cash stops flowing in, alternative investment options present great opportunities for creating wealth.
The markets are cyclical and the downturns don’t last forever. No one’s ever been made rich by following what everyone else does. Alternative investment options in lesser-known industries provide the possibility of greater return when done right.
Peccala's performance during difficult times/crypto bear market
In the previous point, we mainly talked about traditional markets' stocks, fixed-income securities, and ETFs/Index Funds. Nothing new.
This section will focus on the last bullet point for that section: Alternative investment options and it’s most prominent example: cryptocurrency.
The crypto markets are known for volatility and unpredictability. The crypto crash of May 2022 - led by the fall of TerraUSD - wiped out billions of investments/returns, leaving many investors devastated.
Yet, as we’ve mentioned time and time again, volatility creates price fluctuations that drastically lower and raise the value of an item.
It was precisely because of volatility and a focus on trading crypto derivatives that, despite the crypto bloodbath, Peccala was able to adapt and overcome.
Since the Beta launch in March 2022, Peccala’s High Risk Strategy has achieved 170% returns with a peak of 280% returns in the middle of a bear market. When in the same period top crypto coins have lost over 50% of their value, Peccala’s AI-driven trading algorithms have managed to carve out their own path to profit.
Rarely do stocks, bonds, or ETFs/Index funds get this same return at the same time horizon. It took S&P 500 almost 12 months to double its value from its COVID dip in 2020.
Avoid emotional decisions
It might be hard to stomach the highs and lows during a recession, but the important thing is to stay calm and stay in the same strategy you planned. You are in this for the long haul.
If history can tell us anything, the market always bounces back. The markets and their investors are forward-looking. The losses in a recession can be recovered and more.
A good rule of thumb during a recession is to avoid panic selling and obsessively tracking your portfolio. Review your investments periodically and adjust accordingly when your situation changes or the market environment shifts.
Automated investment is your best friend in times of recession
If managing your portfolio is overwhelming, given the unpredictability and emotional swings of the markets caused by recessions, automating your investments may be a better option.
In this way, you don’t have to think deeply about what investment strategy to use and what securities to pick, especially if you are not confident in these areas.
Peccala automates its crypto investments through its AI tools in two different strategies depending on your risk appetite - High Risk Strategy or Medium Risk Strategy. This is helpful if you want crypto returns regardless of market conditions and without stress.
Recessions can be challenging, but taking steps to prepare your finances for a downturn can lessen your anxiety around recessions. So long as you maintain a long-term perspective and a balanced, well-diversified portfolio, be comforted that recessions do not last forever. They are merely blips in the markets and that better days always come.
