Many people would question your decision to invest during a recession. However, a recession can provide excellent investment opportunities.
What exactly is a recession? The NBER (National Bureau of Economic Research) defined a recession period when there is a decline in economic activity resulting in a drop in production and sales and a reduction of GDP (Gross Domestic Product). The economy is said to be in a recession when there has been negative economic growth in two or more quarters in succession.
Here are three things you must not do if you are going to invest during a recession.
1. Do Not Make Investments Without Any Savings
In times of market uncertainty, such as experienced during recessions, you should not be putting all of your money into risky investments. Focus on building up some savings reserves that you can use as a safety net until the recession stabilises and the economy returns to normal.
Ideally, you should have three to six months of savings to cover your living expenses in an emergency. If you’ve already amassed this amount of cash, leave it in your savings account. If not, start saving towards this goal before you make any investments.
Once you have saved up half of your reserves and feel that your income is secure, you may decide to split some of your spare cash into an investment pot and use it to try out the market.
2. If You Do Invest During a Recession, Plan On Leaving Your Portfolio For Some Time
Investing during a recession is not for faint-hearted investors. It is difficult to predict when the recession has bottomed out, and your investments could experience further losses before you start to see some upturn. Investing during a recession requires a long-term strategy, and you should not plan on touching your investments for several years. This time will allow your portfolio adequate time to ride out the storm and recover into profitable territory. Being aware that you may have to accept temporary losses to achieve long-term success will help put you in the right mindset for investing during a recession.
3. Avoid Investing In High-Risk Stocks
Individual stocks can become incredibly unstable during harsh economic times. You might be attracted to investing a large amount of your capital into companies whose stock seems like a bargain. However, recession leads to many companies going bankrupt, so beware of putting a considerable amount of money at high risk.
Luxury brands, hotels, airlines, furniture retailers, etc., are examples of cyclical stocks. These are companies whose sales are linked to consumer confidence and disposable income. When a recession hits, belts get tightened, and spending with disposable income falls. These companies may ride out the recession, or they may crash.
A better investment option during a recession is non-cyclical stocks. These companies sell essential goods and services, so they tend to be more stable during a recession. Energy providers are a classic example of a cyclical stock.
Another risky investment during a recession is in a highly leveraged company. These companies have a lot of debt, putting even more stress on the company during a recession. If they are unable to maintain their debt repayments, they risk bankruptcy. You should research the debt levels of any companies you are investing in during a recession.
An economic downturn can provide an excellent opportunity to make investments. However, bear in mind these three things that you should not do before investing during a recession.