Recessions can be a daunting prospect, particularly for beginner investors and people who aren’t well versed in the history of the stock market. To make matters worse, news outlets and financial analysts are often prophesying an unprecedented, catastrophic recession. But fear not, because today I’ll show you how to invest during a recession and why a recession can actually be a gift for investors.
Many people who invest often ask the question “What do I do if a recession occurs?”. The answer to this question is simple, do exactly what you were doing before the recession. Whether there is no recession, a recession is about to begin or a recession is about to end, your best chance to ride it out and profit in the long run is to maintain your current investment strategy and here’s why:
When a stock fluctuates in price, the capital amount changes. While on paper it may appear that you ‘made’ or ‘lost’ money on any given day, depending on the trend of the stock market, you haven’t made any profits or loss at that stage. To actualise any form of capital gains or losses, you need to physically sell your asset. The intrinsic value of your holdings may be different from when you purchased them, but if you aren’t planning on selling, then there is no actualised gains or losses.
If you are on the path to FIRE, you likely have a long term investment horizon because you will be looking to live off of the income generated from your investments. Recessions don’t inherently pose a risk to your path towards financial independence because you are in it for the long term. This is particularly true for people utilising ETFs that are tracking market indexes because history has shown that on average, the markets generate a positive return more often than not. So while you can be looking at an intrinsic drop of 20-50% of your portfolio during a recession in a given year, if you can hold onto your investments and ride it out, you are virtually guaranteed to make your money back and then some over a long-term investing horizon.
This is why ‘aggressive’ superannuation portfolios that consist of a lot of shares, ETFs and mutual funds suggest a holding period of 10+ years. The 10+ year time frame is factoring in that there may very well be a colossal market correction or recession where your assets drop significantly in value. Yet, this also assumes that from 120 years of market analysis, it is likely that your portfolio will not only recover from that decline in value, but it will also soar above its previous peak value.
Now all of this above information is going on the pretence that even if you stopped investing altogether and simply held onto your portfolio, that you would still come out on top over a long (10+ year) period. However, that’s not in line with your current investing strategy, is it?
Simply put, the most efficient way to come out on top during a recession or bear market is to invest in the exact same way that you have previously been doing. The reason this is a good idea is that if we are facing a recession, the market index and subsequently the shares contained within that index will continuously decline. No one knows exactly how long recessions will last, no one can predict when we are at the worst point during a recession and no one can ascertain whether we are recovering or if it’s destined to drop further. For this reason, simply continue your normal investing patterns and maintain dollar-cost averaging (DCA). DCA is a risk-mitigation strategy that hedges against lump-sum investing before a catastrophic event like the Global Financial Crisis.
When you DCA during a recession, you will continuously be purchasing shares while the market is at a decline. Each time the market drops during your investment window, you will be able to purchase shares at a discount. Each time the market rises, you will be purchasing shares at an increase in value. Through averaging it out, you lower the potential setbacks the recession can cause, as you average out the highs, the lows and everything in between. If you do this, not only will you bounce back once the market returns to its tendencies of growing as opposed to diminishing, you will profit even further from buying shares at a discount.
For the above reasons, recessions aren’t all doom and gloom. They can offer some great discounts on stocks and index funds that can even propel your investment portfolio further than normal. While the temptation may be to hold your money and try and buy at the bottom of the recession, it’s impossible to know when that is. Simply continue investing as per usual, you’ll get some great discounts along the way and won’t have to worry about lump-sum investing at a bad time.
A recession is a great opportunity to purchase assets at a discount. By not panic-selling and trying to time the market, you can expect great long term results if you simply continue investing through DCA. By investing as per usual, you will ride the highs and lows of the economic decline, averaging out any setbacks and increasing your revenue as you ride the economic rollercoaster to new heights.