How To Take Advantage of a Recession
While a recession is a tough time for the economy in general, there are always pockets of opportunity in every downturn.
In fact, there are many axioms that suggest that wealthy investors actually look forward to recessions, from the age-old expression that “millionaires are made when the markets are down” to billionaire Warren Buffett’s famous maxim, “Be fearful when others are greedy, and greedy when others are fearful.”
But, as an average investor, is there a way that you too can benefit from a contracting economy? The simple answer is yes. Here are some ideas for how to take advantage of a recession.
Lower Your Average Cost
Typically, the stock market sells off about six months before a recession actually hits, and the drawdown can be dramatic. In the first half of 2022, for example, the S&P 500 was down 21% from its high, and as of Aug. 29 it was still down more than 15% year to date.
It’s certainly painful to look at your brokerage statements at times like these, but it’s also a great opportunity for long-term investors to pick up additional shares. For example, if you bought $5,000 worth of a stock priced at $100 and it is now down to $80, another $1,000 investment will bring your average cost to just $90 per share. Not only will it be easier for you to break even, but a return to your previous purchase price of $100 will now result in profits, rather than simply breaking even.
Pick Up Cheap Dividends
When stock prices fall, their dividend yields increase — all other things being equal. For instance, if a stock trades at $100 and yields 2%, that same stock will yield 4% if the price falls to $50. That’s twice as much income for shareholders who buy in at the lower price. You’ll have to be a bit careful here, as some stocks that lose half of their value have business issues that could result in a dividend cut. But if a high-quality company sees its share price fall simply due to negative overall market sentiment, it’s a great way to pick up a big income stream on the cheap.
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Buy Index Funds
A recession is an economic contraction, and the unfortunate truth is that some companies don’t survive. While many stocks that trade lower during a recession can and do go on to make new all-time highs, others find themselves in an irrecoverable spiral down that could eventually lead to bankruptcy.
For this reason, it makes sense for many investors to load up on index funds during a bear market rather than trying to pick individual stocks. Although there are no guarantees going forward, historically speaking, the market indexes have always recovered and gone on to make new highs after navigating a bear market. While you may see greater returns with individual stocks, investing in an index fund is typically less risky.
Boost Your Emergency Savings
During a recession, it pays to dump as much money as you can into your emergency savings. Not only might you need additional funds for emergencies — or to help cover unexpected jumps in prices — you likely will benefit from a higher savings yield.
Recessions are often concurrent with rising interest rates, as the Fed increases the federal funds rate in an effort to combat inflation. Eventually, yields tend to fall again; but, in the early stages of a recession, rates tend to be high and rising.
Savings accounts — particularly the online variety — often see dramatic jumps in the interest they pay to customers during these times. From November 2020 to August 2022, for example, the savings yield at online bank Marcus popped from 0.50% to 1.70%, a rate that’s likely to go even higher as the Fed continues its battle against inflation.
Wait for Lower Interest Rates
Just like the early stages of a recession are a good time to take advantage of higher savings rates, coming out of a recession is a good time to take advantage of lower interest rates.
Typically, by the end of a recession, the Fed has begun lowering rates in an effort to stimulate the economy. In some cases, rates can fall quite low. While the recession triggered by the coronavirus was an unusual case, the Fed responded to it by lowering the federal funds rate to essentially zero. This drove mortgage interest rates to an all-time low of 2.65%, offering a great opportunity for both investors and first-time homebuyers alike.
While rates aren’t likely to fall quite that low coming out of the next recession, you may be able to take advantage of rates that are lower than current levels.
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