How to invest in a recession

The National Bureau of Economic Research (NBER) announced that the United States officially entered a recession in February 2020. The economic peak in February 2020 came after the longest period of expansion in US history – a period which lasted 128 months. The previously held expansion record of 120 months was between 1991-2001.

What is a recession and what does it mean?

Before we dive into the details of how to invest in a recession, it’s essential to understand what a recession is and what it entails. A recession is generally defined as a considerable decline in economic activity which lasts for more than just a few months. NBER analyzes data including Gross Domestic Product (GDP), income levels, rates of employment, production, and retail sales in order to assess the state of the economy.

Since this data is backward-looking, it’s no surprise that when NBER announces a recession, most of us feel it’s something we’ve already known for months.

Thankfully, recessions have historically been brief and do not occur frequently. Economies in a normal state expand – the opposite of a recession.

What causes a recession?

There are a number of contributing factors that can lead to a recession. Some of which include:

– Loss of consumer confidence in the economy

– Stock market crashes

– Asset bubble bursts

– Deflation

– Falling housing prices and sales

Now we can add global pandemics to the list too.

What happens during a recession?

While recessions in the US tend to be brief and infrequent, they occur often enough that economists have been able to analyze their trends. Some of the more common characteristics of recessions include increased unemployment, reduced consumer spending, decreased real estate values, and low interest rates.

How does a recession differ from a depression?

Recessions and depressions have very similar characteristics and essentially impact all of the same facets of the economy. The main difference between the two is the length and severity of the economic downturn. For context, the rate of unemployment at the 2010 peak of the Great Recession was 10.6%. In contrast, unemployment rates during the Great Depression in 1933 peaked at 25%.

Additionally, the Great Recession lasted for a total of 18 months. Mind you, one of the reasons it earned its name was because it far exceeded the length of the average recession in US history by an additional 7 months. While 18 months is certainly not a short amount of time, it pales in comparison to the Great Depression of 1929 which lasted for 10 years.

Strategies for how to invest in a recession

Now that we’ve covered the basics of what a recession is, we can dig into strategies for how to invest during a recession.

Recognize the silver lining

While there are a tremendous number of downsides to a recession, it’s important to recognize that recessions don’t come without a few silver linings. One of those silver linings is a powerful buying opportunity. In the words of Warren Buffett:

“Be fearful when others are greedy, and greedy when others are fearful”

It’s painful to watch the prices of stocks you already own plummet. But along with that pain comes an opportunity to buy quality stocks which were previously out of your financial reach. Recessions provide investors with the ability to buy stocks well below their value.

Understand your financial situation first

Just because you can afford to buy a stock doesn’t mean you should. Remember, recessions are relatively infrequent and historically brief. So, it’s important to continue evaluating your investment opportunities over a long time horizon. It’s also essential to understand your time-to-retirement horizon. If these factors aren’t something you’re comfortable evaluating on your own, speaking with a financial advisor will be your best bet.

Investing in Recession-Resistant Industries

Dave Ramsey said it best when he shared that personal finance is not rocket science (fortunately for all of us!)… “money is 80% behavior and 20% knowledge”. Thinking about investment opportunities in those terms, all you need to do is follow your own pocketbook to determine what industries are likely to do well, despite an economic downturn.

These include:

Big Box Discount Retailers

Where did you and all your neighbors go to stock up on supplies and get them at a good price? Discount retail businesses like Costco and Sam’s Club tend to do very well during recessions as consumers become increasingly cost-conscious.

Healthcare

Whether the recession is related to public health or not, healthcare is considered a static industry. Regardless of the state of the economy, people are always in need of healthcare services.

Utilities

Similar to healthcare, utilities are an essential service. Whether or not the economy is in a downturn, individuals and businesses still need to keep the lights on.

“Sin” industries

“Sin” industries include businesses perceived to be less than ethical and/or geared towards adults only. These include alcohol, tobacco, gambling, etc. Consumers may be tightening their pursestrings during a recession, but consumer spending has typically gone up in these sectors during stressful economic times.

Consider investing in dividend-paying stocks

Dividend-paying stocks have traditionally done well, even during recessions. These stocks are not recession-proof by any means, but companies that pay dividends are more likely to be flush with cash. Receiving dividends during an economic downturn can serve as a passive income stream or be reinvested back into the stock market. It’s important to note that just because a company has consistently paid dividends in the past, doesn’t mean they may not reduce or cut them altogether.

Consider investing in real estate

Real estate provides a physical asset investment opportunity during a recession. Similar to stocks, you may have the opportunity to buy real estate at a much lower price than you would be able to in a strong economy. Moreover, recessions tend to coincide with lower interest rates, which will also ultimately reduce the cost of your investment property.

Before you completely disregard the idea of investing in real estate, know there are a number of options that don’t involve you becoming a landlord. Buying into REITs (Real Estate Investment Trusts), using SEC vetted online real estate investment platforms, and flipping properties are just a few options worth mentioning.

Diversify your portfolio

Proper diversification of your portfolio is a best practice regardless of whether or not the economy is in a recession. But, if a current or impending recession has you feeling particularly anxious, it may be a good indicator that your portfolio isn’t well diversified and/or you’re too aggressively invested.

No investment is risk-free. If you see any investment advertised as risk-free, that’s your cue to turn around and run. Proper diversification, on the other hand, can significantly reduce your overall investment risk while still providing a positive return on investment.