The word “recession” can send chills down the spine of any investor. When it hits, the stock market usually crashes, your 401(k) loses value, beloved businesses shut down, and media ramps up the panic about financial turmoil.
A recession is defined by the National Bureau of Economic Research (NBER) as a significant drop in economic activity across the economy lasting more than six months, typically visible in GDP, income, employment, industrial production, and retail sales. Since 1777, the U.S. has experienced 47 recessions.
Market declines and uncertainty during a recession can be unsettling. However, navigating a recession is a true test for any investor. Investing isn’t just for the good times; it involves risk, and during a recession, the risk becomes very real.
To avoid irrational decisions during a recession, it’s crucial to adjust your mindset and remember that recessions are temporary, generally lasting around 11 months. If you approach it strategically, a recession can become an opportunity to make smart investments.
First, avoid selling any stocks or funds that include stocks during a recession. Although it might seem like the only way to prevent losses, selling during market lows will just lock in those low prices. Instead, maintain your current stock allocations and consider these actions:
Take advantage of low stock prices by increasing your stock allocations through monthly retirement plan contributions. For instance, change a portfolio from 60% stocks and 40% bonds to 80% stocks and 20% bonds. If possible, increase your contribution level altogether, say from 10% to 15% of your 401(k). Investing more at discounted prices can result in greater returns when stock values rebound.
Rebalance your portfolio by selling funds performing well and using that money to buy undervalued stocks. Although it feels counterintuitive, this approach ensures you buy low and sell high, taking advantage of increasing bond and cash investment prices.
To avoid self-sabotage, disconnect from daily market updates during a recession. Constantly checking your portfolio only fuels worry and panic, which can lead to regrettable decisions. Ride out the storm; it will pass eventually.
Investing in dividend stocks is another strategy during a recession. Dividend stocks pay shareholders a portion of the company’s profits quarterly, typically yielding 1-4% annually. During a market downturn, buying these stocks at lower prices means you’ll receive more dividends as their value eventually increases. Companies with strong financials that can continue paying dividends are generally more stable.
Dividend Aristocrats and Dogs of the Dow are two reliable places to find great dividend stocks. The Dividend Aristocrats are companies with a track record of not cutting their dividend payouts for over 25 years. Dogs of the Dow are the ten companies in the Dow Jones Industrial Index with the highest dividend yields. Buying these stocks can be profitable over time.
Real estate, another asset often affected by recessions, can also present lucrative opportunities. Depressed real estate prices can be beneficial for those looking to upgrade their homes or acquire rental properties. Buying real estate investment trusts (REITs) is another way to profit from real estate without owning physical properties. REITs pool investor money to finance large-scale projects, offering high dividend yields since they distribute at least 90% of their taxable income to shareholders.
If stocks and real estate feel too risky, building an emergency fund is a valuable alternative. Financial advisors recommend a fund covering at least 3 to 6 months of living expenses for unforeseen circumstances. Though it may seem unproductive to keep that much cash earning minimal interest, it acts as a financial safety net, preventing high-interest debt or the need to raid retirement savings during tough times.
In conclusion, while recessions are challenging, they also offer unique investment opportunities. By keeping a cool head and taking strategic actions, you can not only safeguard your investments but potentially grow them when the economy recovers.
