It’s no secret that the economy isn’t doing well right now. The rise in inflation coupled with the hawkish stance by the Federal Reserve might soon push us into a recession.
Economists are watching an inverted yield curve, one of the most reliable predictors of a recession. The New York Fed model says the U.S. economy will contract this year and next, assigning an 80% probability to a hard landing.
Investing in A Recession
During down economic cycles, many investors like to flee to safe-haven assets, like cash or U.S. Treasury bonds, while most risk assets like stocks tend to drift lower and lower.
Investors want to get out of the market and put their money into safer accounts.
Warren Buffet’s famous quote is to be “fearful when others are greedy, and greedy when others are fearful.” However, it is not wise to time the market bottoms. There is no way to know when bear markets have hit their bottom and when it is time to buy. Dollar-cost averaging is the best strategy when investing in recessions or boom times.
Buying Stocks During A Recession
The stock market is divided into the following 11 sectors.
- Consumer Staples
- Consumer Discretionary
- Health Care
- Information Technology
- Communication Services
- Real Estate
Investing in specific stock market sectors does better in an economic downturn because consumers still need their products and services, even during a recession.
The sectors that consumers have difficulty cutting back on include:
- Consumer Staples
- Utility Companies
During economic downturns, many investors focus their investments on high-quality stocks that pay dividends. This is because dividends will offset losses in a portfolio and reduce portfolio volatility.
Money from investments that pay dividends can be put back into the stock as an investor will average down, which is an excellent way to accumulate more stock when the stock is cheap. One can put the money from dividends into saving or investing.
However, be wary of high dividend yields since usually these are mature sectors and won’t offer much upside when the recession ends. Also, a high yield doesn’t necessarily mean it is an outstanding stock to buy.
The yield may be elevated because the stock price has recently dropped. And if this drop occurred because of something wrong with the company, then there is a risk the company will cut its dividend soon.
Mutual Funds and Exchange-Traded Funds
Mutual funds and exchange-traded funds (ETFs) are similar in that they both are baskets of various investments like stocks and or bonds. Unless an investor is very good at picking individual stocks, it might be best to consider broad-based index funds.
Investing in the S&P 500 provides diversification to all sectors of the economy based on market-cap weighting. In addition, one gets exposure to defensive and growth industries that could help your portfolio after the recession ends.
Bonds usually do well in a recession, and moving money into bonds or bond funds is considered a safe move.
Bonds are known as fixed-income investments because they pay a fixed amount of interest.
However, bond funds do not do well if the recession is inflationary with rising interest rates, as we have seen in 2022.
Shorter-duration bonds, in general, outperform longer-dated ones in a rising rate environment. Therefore, holding individual bonds to maturity or building a ladder of individual bonds is advisable in an increasing interest rate environment. Investing in I-Bonds from the U.S. Treasury is a low-risk strategy ensuring your cash keeps up with inflation.
The San Francisco Federal Reserve published a paper titled “The Rate of Return on Everything, 1870–2015,” which shows that residential real estate, not equity, has been the best long-run investment throughout modern history (1870 to 2015).
The most important part of the study was that although returns on housing and equities are similar, the volatility of housing returns is substantially lower.
Even though the Federal Reserve Bank is likely to raise interest rates, there are still many reasons to be excited about investing in real estate.
Traditionally, real estate has been a great way to hedge against inflation. Typically, the value of real estate rises faster than inflation since your mortgage payment is fixed, but one can raise rents to market levels, keeping pace or exceeding inflation.
Also, when the interest rates fall, one can refinance at lower mortgage rates.
Since it is doubtful that wheat will come out of Russia or Ukraine in 2022, now is an excellent time for farmland investing. In the past, investing in farmland was available to only the ultra-wealthy. However, with technological advances and crowdfunded investments, farmland is accessible to almost everyone.
Farmland is well-suited to retain value over time, even during recessions. Farmland value increases when agricultural products become more expensive since the underlying land becomes more valuable.
Land in rural America has had a steady increase every year. Per the May 2022 Ag Credit Survey published by the Federal Reserve Bank of Kansas City, farmland values continued to increase rapidly through the end of 2021. Alongside sustained strength in farm income and credit conditions, the value of all types of farmland in the Tenth District was more than 20% higher than a year ago.
The recent strength in agricultural real estate markets has been supported by solid demand, historically low-interest rates, and vastly improved conditions in the farm economy.
Investing in Yourself
In a recession, your human capital is your most valuable income-producing asset. Keep your certifications updated and your contacts warm even if you plan to quit your job.
And if you are still working, increase your high-income skills so you can be the last to be laid off or the first to find a better-paying job. Or better yet, use your skills to start a passive income business.
Of course, passive income involves a lot of effort upfront. However, having multiple income streams is always a great risk mitigation strategy, even if we are not in a recession.
As Warren Buffet said, “Your best investment is yourself. There is nothing that compares to it.”
Staying Safe While Investing During a Recession
When it comes to investing during a recession, there are several things that you can do to stay safe. First, it is essential to diversify your portfolio by investing in various assets, such as stocks, bonds, real estate, and cash equivalents. Doing this can minimize your risk if one asset class decreases in value.
Another tip is to avoid leverage. Leverage is when you use borrowed money to finance your investment. It can help you make more money if the investment goes up in value, but it can also amplify your losses if it goes down.
Finally, it is crucial to have a long-term perspective. It means you should not try to time the market by buying at the bottom and selling at the top. Instead, it would help if you focus on purchasing quality assets and hold them long-term.
While recessions are often viewed as adverse events, they can also offer opportunities for businesses and individuals to make long-term investments at reduced prices. For example, during the Great Recession of 2008-2009, many companies and individuals took advantage of low-interest rates to invest in real estate, stocks, and other assets.
As a result, those who were able to weather the recession were well-positioned to benefit from the subsequent economic recovery.
While there are no guarantees when it comes to investing, these tips can help you stay safe while investing during a recession.
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This article was produced by Financial Freedom Countdown and syndicated by Wealth of Geeks.
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John came from a third world country to the US with only $1,000, not knowing anyone, guided by an immigrant dream. In 12 years, he achieved his retirement number.
He started Financial Freedom Countdown -https://financialfreedomcountdown.com/ to help everyone think differently about their financial challenges and live their best lives. He resides in the San Francisco Bay Area, enjoying nature trails and weight training.