When the economy is down, it's normal for you to be curious about how you can make money by investing. Certain investments, such as stocks, can be more risky in a down market. However, you might be able to see large returns from a recession if you follow these basic and timeless strategies.
How to Make Money Investing in a Recession
While it's tempting to try to time the market when stock prices are low and falling, you might be shocked to hear that the best way to invest during a recession is the same as when the economy is growing.
Continue to Dollar-Cost Average (DCA)
Whether you're regularly contributing to a 401(k) or an IRA, or investing through your broker, it's wise to continue doing so during a recession if you can. The idea of dollar-cost averaging is that you buy shares at higher prices when the economy is strong, and lower prices during a recession.
As you buy lower, you are making the average price you pay for stock lower, which tends to boost returns in the long run.
Rebalance Your Portfolio
You can change the balance of your holdings when you notice prices falling. You then rebalance your holdings or return your asset allocation to its original targets.
For example, if your target balance is 60% stocks and 40% bonds, your stock portion is likely lower, and your bond portion is higher during a recession. When you rebalance during an expansionary phase, you'll sell bonds and buy stocks to return to your target allocation.
Keep a Long-Term View
If you're buying stocks or stock mutual funds, likely, you won't need to withdraw from your account(s) for at least five years to ten years. For that reason, you shouldn't worry too much about short-term market changes.
Don’t Discard Your Strategy During a Recession
Stock prices might be down, but that doesn't mean you need to change the way you invest. This thought process applies to long-term investors, short-term investors, and retirees.
Recessions are not declared until after many factors are analyzed. If you plan to sell right before one hits, you're more likely to miss it and lose money.
If you're regularly adding funds to a long-term account, such as a 401(k) or IRA, don't stop during a recession. If you place most of your money in stocks, don't "chase performance" and sell out of them. They may be falling in price while bonds are rising in price. If that is the case, you could lose more money than if you were to stay in stocks. If you have chosen your stocks and funds with care, you will end up with more than you started with. Stay the course.
Short-Term Investors and Retirees
Although you may be uncomfortable during a bear market, don't be tempted to sell your stocks or stock mutual funds at a loss. If you need income right away, it would be best to have money set aside in cash and bonds before the downturn. That way, you can withdraw from your cash while you wait for stock prices to recover.
Take on as Much Risk as Your Tolerance Allows
If you want to make good use of a market correction during a recession, try not to buy more stocks than you would during better times. If your risk tolerance allows you to accept a moderate asset allocation of 65% stocks and 35% bonds, you should keep that target, no matter what the market is doing.
Investing Before and During a Recession
It's easy to go wrong during a recession if you forget or don't understand how certain investments perform during a downturn and how they are related.
The stock market looks ahead, and economic reports are reviews of the past.
Stock prices often fall months before a recession begins, which also means that they often bounce back up before the recession is declared over. You can miss an entire downturn if you only follow the news. That is why it is vital to know the signs of a recession and recovery, and how assets perform during those periods:
- Stocks: Prices for stocks tend to fall before the downturn begins and almost always before a recession is called. If you're trying to make use of lower prices, you'll likely benefit most if you buy before the recession starts or during its early phase.
- Bonds: Prices for bonds tend to rise during a recession. The Federal Reserve (the Fed) stimulates the economy by lowering interest rates and purchasing Treasury bonds.
- Cash/deposit accounts: Since interest rates fall from the Fed’s actions, they tend to do so on deposit accounts as well. However, cash and insured accounts are free from market risk, unlike bonds and stocks.
- Gold: Most investors see gold as a haven. The price of gold often rises as markets plunge. Investors begin buying stocks again when things are looking up and sell their gold. That pulls gold prices back down again in another mass sell-off.
Risks vs. Gains of Investing in a Recession
Stocks, stock mutual funds, and ETFs are risky during an expansion. They are even more so during a recession. It helps to compare the gains and risks of buying stocks during a downturn.
Before and early in a recession, stock prices often fall, making it a good time to buy. If you're one who continues to dollar-cost average into your 401(k) plan, IRA, or other investment accounts, buying as stock prices fall pays off in the long run.
Timing the market and trying to buy when prices are low or beginning to recover is risky. You can still face lots of volatility, even if the market seems to have fully recovered. This is called a "bear market trap." You can get caught up in the optimism of the moment, only to see another fall in prices after the short-term rise.
The Bottom Line
Certain investments have performed in similar ways during recessions of the past. However, no one can predict what will happen in the market in the near term. Stock prices can suffer a large fall over one month, then rise again the next month, only to fall again a month later.
Since no one can predict what the stock market will do and how people will react in the short term, it's wise to commit to your investment strategy during a market downturn so you can participate in the recovery.