Should Investors Fear a Recession?
This is the million-dollar question: should investors fear a recession? It’s reasonable to worry about an economic downturn. That’s because of its effects on you and those you care about. These effects include increased unemployment and financial instability. Young investors with a diversified portfolio and a lengthy time horizon shouldn’t worry about a recession affecting their capacity to accumulate money over time. Yes, even if you’re worried about your career. A recession may help you.
In this article, I’ll address the question: should investors fear a recession? I’ll also review why it’s feasible for investors to profit from an economic slowdown, as well as offer some tips on how to keep your wealth secure when the economy is in a slump.
Recessions are common and typically last for a short period of time.
First, what is a recession? According to the National Bureau of Economic Research (NBER), there have been 34 recessions since 1854, including the one that is anticipated to occur in 2020. According to the NBER’s definition, this amounts to a recession occurring once every 4.94 years on average. It is crucial to remember that a recession is defined by the National Bureau of Economic Research (NBER) as “a considerable reduction in economic activity” that lasts “more than a few months,” not necessarily two consecutive quarters. The essential lesson is that, even if this is your first recession, it is unlikely to be your last.
Even while economic downturns are common, there is some good news: they do not persist indefinitely. To this day, the United States has effectively emerged from every recession. According to NBER research, recessions lasted around 11 months on average between 1945 and 2009. That isn’t a long time, especially if you intend to invest for the long term.
Even during a recession, you can still make money by investing
You have the possibility to buy investments at a lower cost.
Assume you have a favorite brand of cereal that you eat every morning and buy a box of it once a week or so at the grocery. If the cereal was on sale for a few weeks or even months, there’s a strong chance you’d buy more boxes.
This makes excellent sense, but some investors struggle to apply the same logic to situations in which equities are offered at a discount. During a recession, the stock market often loses a large amount of value; historically, the S&P 500 has lost roughly 29 percent on average. If, on the other hand, you believe that the market will soon rebound (which it always does), you can view the current state of the market to be a sale situation, similar to how the price of your favorite morning cereal recently plummeted. According to this logic, it is a positive event when the market is temporarily down and you can buy investments at more inexpensive costs.
A declining market can be more profitable than a growing one. You can take advantage of this by adopting dollar-cost averaging, which means investing $100 every week or $500 per month. Over time, you’ll buy investments at different costs, with some being cheaper during a recession. You can invest without worrying about the “right timing.”
Harvesting losses may allow you to lower your tax liability.
The temporary decline in the value of your portfolio is never pleasant, but there is a silver lining: the chance to collect tax losses. If the value of an investment falls below its original purchase price, you have the option of selling it at a loss and replacing it with another investment of a comparable sort. As a result, you can “harvest” the loss while maintaining the overall risk and return characteristics of your portfolio. When filing your taxes, you can deduct that loss to lessen the amount you owe.
Tax-loss harvesting by hand can be a time-consuming and labor-intensive task. Wealthfront’s Tax-Loss Harvesting tool, on the other hand, handles the process automatically and at no extra cost. Clients that began using our Tax-Loss Harvesting service the previous year received tax savings worth four to nine times the consultation fee in 2021.
How investors might better prepare themselves for an economic slump
Recessions tend to raise unemployment rates, therefore now is a good time to save up. Most people need a cash cushion to cover three to six months of living expenses. Age, nature of employment, amount of investable assets, and family financial needs determine the proper amounts. Keep emergency savings in a high-yield account like Wealthfront Cash. This account gives a 1.40 percent annual percentage yield (APY), no market risk, and four times the FDIC guarantee of a typical bank account.
Having a substantial cash reserve set aside for unforeseen needs helps alleviate tension. If you are concerned about losing your job, it is possible that you will find it easier to sleep at night if you know you have enough money to cover your bills until you find new work.
If you do lose your job or your salary, we strongly advise you to immediately cut your spending (which will allow your emergency fund to last longer) and enquire with your service providers about any payment extensions they may be able to grant.
Even if the value of your investments has decreased, you should continue to invest.
When the economy slows, a person’s investment portfolio will be worth less than the day before. When logging into a brokerage account, no one wants to see this. Some investors may sell their assets to cut their losses as much as feasible. If so, check your portfolio less often until the market recovers. This method won’t affect your portfolio’s performance, but it will help you retain consistency, which is key to long-term success.
Make sure your investments are distributed throughout multiple marketplaces.
During a recession, diversification is key to increasing risk-adjusted returns. If you don’t put all your eggs in one basket, you’ll be better prepared for economic losses. If you believe you’re protected from losses, it will be easier to invest.
Press headlines may suggest investing in specific asset classes or businesses during a recession. Wealthfront’s Classic, Socially Responsible, and Direct Indexing portfolios are globally diversified across a wide range of asset classes to survive all market circumstances (unlike, say, just investing in a US stocks index fund). Adjusting your asset allocation in reaction to market conditions is market timing, and scholarly research has shown it to be ineffective.
The minimal necessities
With that, should investors fear a recession? Even though they are disturbing, recessions are an unavoidable part of long-term investing. They have always been able to recover and may even be rewarding for investors in the end. If you haven’t lost your job or assumed increased financial responsibility for a family member, stick to your investing approach and ignore the news (in which case, you may need to slow down the rate at which you put money into the market). If you continue to harvest your losses, adjust your portfolio on a regular basis, and make regular deposits, you have a decent chance of succeeding in a recession.