The Strategy for Investing in a Recession

No one knows if the stock market is going to go up or down tomorrow, next week, or next year. If anyone tries to tell you that they do, they’re either lying or they’re lying.

The truth is, the S&P 500 could go skyrocket or crash at any minute, and while that might sound scary, it doesn’t have to be if you have the right strategy in place. Most importantly, the right strategy for investing when a recession hits.

Investing in a recession is not that different from investing during any other time period, especially if you’re a long-term investor that is not retiring any time soon.

Though, a recession or bull market, the first step every prepared investor needs to take is to cover the basics.

Covering The Basics

Build Emergency Fund

Every new investor needs to consider building an emergency fund.

An emergency fund is exactly what it sounds like – money you have set aside for emergencies. Usually, it’s put in a safe place (like a high yield savings account or money market account) and can be used for any surprise events, like a large medical bill, car expense, or unexpected layoff.

The amount of money you put in your emergency fund typically spans between 3-6 months of expenses. Though, many people choose to invest more or less depending on their unique situation.

Know Your Budget

You don’t necessarily have to build a budget from scratch, but everyone should have a rough understanding of their income, expenses, and savings plan.

It’s hard to plan for the future, let alone survive the next recession, if you don’t have a firm understanding of how much money you need to make every month to stay afloat.

Have an Investing Plan

Last but no least, everyone should have an investing plan. Which would include having answers to common questions like:

• What investment accounts are you using?
• How much do you contribute to your investment accounts every month?
• What is your target asset allocation?

Answering those 3 questions can help build a sound foundation for investing. For example, for myself, the answers look like:

• Investment Accounts: 401(k), Roth IRA, and Personal Brokerage Account.
• Contributions: I max out my 401(k) to get my employer contributions, then max our my Roth IRA, and last I contribute leftover money (after all expenses) to my personal brokerage account.
• Asset Allocation: I have a long time horizon until retirement, so I target about 90% of my investments into equities and 10% into bonds and REITs. This is separate from my emergency fund that I keep in a high yield savings account.

If you need more information on building an investment plan, my two favorite resources are:

• My Ultimate Guide to Index Investing
• How to Set Up a 3 Fund Portfolio (Lazy Investing)

With the basics covered, let’s dive into what else you should do when investing in a recession and are in the midst of an economic downturn.

What is a Recession?

First, a quick primer on what defines a recession, which has a surprisingly loose definition.

Investopedia states that a recession, “is typically recognized after two consecutive quarters of economic decline, as reflected by GDP (gross domestic product) in conjunction with monthly indicators like employment.”

In simple terms, if the US economy declines for 6 straight months, it could be classified as a recession. A struggling US economy means that companies will see profits miss growth expectations and stock prices will decline as a result.

Ultimately, a non-profit called The National Bureau of Economic Research (NBER) is who officially declares a recession in the US. The last recession in the United States was the Great Recession that took place in 2008.

Note: Similar to recessions, depressions do not have a firm definition. They are typically viewed as economic declines that last for multiple years.

Investing in a Recession: What to Do When it Hits

The first step to successfully investing in a recession is to determine how many years you are from retirement.

For these purposes, if you’re more than 10 years away from retirement, we’ll say you’re far from retirement.

If you’re 5-10 years away from retirement, or less, we’ll say you are close to retirement.

If You’re Far From Retirement…

When you have more than 10 years to go until you retire, a recession and market crash can be a very good thing for you.

Before you get all worked up by me calling a recession a “good thing”, remember I’m talking strictly from an investing standpoint. If you lost your job or income, that can be devastating, but let’s assume you’re lucky enough to keep your job during a recession.

If thats the case, then you have the opportunity to buy stocks on sale at a 10%, 20%, or even 30% discount.

Do you get mad if you’re favorite clothing store offers a 30% off sale? No, probably not. This is (kind of) the same thing!

It’s Not Real Until You Make it Real

Any assets that you hold in the market do not actually lose value until you sell. If you are a young investor who saw $50,000 turn into $40,000 overnight, don’t panic. For now, it’s just numbers on a screen (or piece of paper).

You have not actually lost $10,000 until you sell your investments!

Instead of selling in a panic, you should stick to your investing plan and focus on what your accounts will look like 10, 20, and 30 years down the line. It should look a lot better than it does today.

Plus, buy some cheap stocks while you’re at it (and by stocks I mean index funds).

“Far from Retirement” Strategy for Investing in a Recession:

• Stick to your investing plan
• Don’t sell in a panic
• Purchase additional equity “on sale” if you have spare cash

If You’re Close to Retirement…

When you’re just a few years from retirement, you might need to take a more conservative approach than doubling down when stocks go on sale.

Hopefully, as we outlined in the covering the basics section, you had a proper asset allocation. Meaning, you had the right balance of cash, bonds, and equity based on your age and risk tolerance.

The last thing you want to do here is pull money out of the market when it’s at an all time low.

Though, instead of funneling more money into the market while everything is heavily discounted, it might make more sense to pull back slightly in order to build up your cash reserve (or invest in bonds). This will help cover your bases in case this recession lasts a long time and turns into a depression.

“Close to Retirement” Strategy for Investing in a Recession:

• Don’t sell in a panic
• Consider shifting typical equity purchases to bonds or cash

What Not to do During a Recession

Whether you’re close to retirement or not, here are a few universal rules of what not to do during a recession.

Don’t Panic!

Stay calm.

A recession can be an unnerving time, but you have a plan, and you should stick to it.

Don’t Sell Low

Unfortunately, many investors sell during low points in the market because they want to stem their losses. Usually, these are the same people who get in at market highs because “everything is doing so well” and they want in on the action!

Essentially, they end up selling low and buying high. That’s a bad strategy.

The best thing you can do to avoid making that mistake is to ride out the market lows and highs by sticking with a long-term plan.

Don’t Forfeit Your Income

Lastly, do everything you can do keep making money and produce a steady income during a recession.

I understand that is much easier said that done, especially if you lose your job during a recession, but keeping an income helps mitigate the need to withdraw your investments early. Which is the last thing you want to do during a recession.

So whether it’s getting a part-time job, side hustling, or working from home, do everything you can to cover your expenses with income.

Summary: Strategy for Investing in a Recession

The bottom line is that the best thing you can do in a recession is to be prepared, which comes by covering the basics before a recession happens. It’s hard to completely recession-proof your portfolio, but there steps you can take to help protect against a market downturn.

Once you’re in a recession, the best strategy to implement depends on how far you are from retirement.

If You’re Far From Retirement:

• Stick to your investing plan
• Don’t sell in a panic
• Purchase additional equity “on sale” if you have spare cash

If You’re Close to Retirement:

• Don’t sell in a panic
• Consider shifting typical equity purchases to bonds or cash

The strategies above are short and sweet because you should not make huge, rushed decisions during a recession. You should be prepared, and make small and intentional changes to your plan in order to set yourself up for success in retirement.