Get Comfortable with what Risk, Gains, and Returns look like.
It is important to remember that the 20%/30%/40% returns stocks and accounts saw over the last 5 years are what is really the annually here. These returns are not sustainable and some return to fundamentals is inevitable. So it’s important to keep the focus on what your risk, gains, and returns should look like.
If you want to make the most of a recession, it’s not a good time to test your risk tolerance. Stick to your guns. If you have worked with your CFP® you should have a good feel for your risk tolerance. If you are aggressive when the sky is blue, but cautious when the rain falls, you were always cautious. And you should invest accordingly. Seeing a market sell-off might lure investors to add risk to their portfolio, but if you are pushed past your comfort level and there is a continued or second sell-off, then you have only reinforced the need to control risk.
So try not to buy more stocks than you would during better times. If your risk tolerance allows you to accept a moderate asset allocation, then that should reflect your behavior in good times and bad. Let the rebalancing and reinvestment process reward your behaviors.
Risks vs. Gains of Investing in a Recession
Stocks, stock mutual funds, and ETFs are risky during an expansion, even if that risk is ignored by markets going up. The only time people seem to be aware of their risk is when the markets are falling. This is why you should find an exposure with your CFP® that uncovers the “risk” in fair and foul weather. It helps to compare the gains and risks of buying stocks during a downturn.
Before and early on in a recession, stock prices get very volatile. The first warning sign is that risks are revealing themselves. But this is also a remarkable time to buy. If you’re one who continues to dollar-cost average into your 401(k) plan, IRA, or other investment accounts, buying as stock prices fall pays off in the long run.
Shift your focus on both the time you will need this money, and the price you are getting for these stocks today. Paying less for companies that are earning money is a better focus point than looking at how much up or down the stock is.
Timing the market and trying to buy when prices are low or beginning to recover is risky. Largely because the risk is neither, on nor off, it is constant. So buying with the crowd, or as the result of a headline means you are chasing the “risk”. The swings get crazy during a recession and those that buy constantly, and with a cadence find that at some point they “got the best price” even though every time they bought it wasn’t a low point. Fast forward a decade, and they care little about the $30 stock they bought at $22 vs. $20 but at the moment the 10% swing felt steep.
It is also important to remember, that you can still face lots of downside pressure, even if the market seems to have fully recovered. This market motion is called a “bear trap.” You can get caught up in the optimism of the moment, only to see another fall in prices after the short-term rise. But those with a plan to repeatedly buy at the bear market find they buy small “deals” along the near bottom and some when the real bottom is in.
The Bottom Line
Financial markets are the single most efficient way of transferring money from the national and global markets to cash in your bank account. Recessions are by their definition a period in which the speed of that transfer slows down, not stops. So those that accumulate assets up to and through a slow down reap the benefits when the pace of that flow speeds back up.
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