How to Invest During A Recession
By Michael Mikonis, CFP®, RICP®
During times of market or economic uncertainty – when we are not sure what will happen to our 401K balances or if we will still have a job at the end of the coming quarter. One thing that is for sure to happen, almost every “news” outlet gets covered by headlines: “Best 10 stocks to own during a recession” or “Best Recession Proof Stocks” or my favorite “How to make money during recession”.
After reading a few of these articles, you will soon realize that advice pretty much stays the same, it might vary from author to author a bit, but for the most part, they all sound something like this:
Buy “core” stocks – which are stocks from companies that produce basic items that everyone will need, even during times of recession.
Buy dividend stocks!
Invest in precious metals!
Pay down debt!
The problem with these articles is that they tend to all fall into one very big category called “Too Little – Too Late”. The main reason they all fall into this category is that no one knows where or why the next Recession will occur, and reacting AFTER the stock market is already down 40%-50% is usually … you guessed it - “Too Little - Too Late”.
There is nothing wrong with buying stocks of companies that produce everyday necessities. Except that they tend to not do all that well during good economic times and can even stay stagnant. People will not all of a sudden brush their teeth 4 times per day just because the economy is doing well, nor will they all of a sudden start pouring twice as much dishwashing soap into the dishwasher. These companies produce items that constitute a relatively small portion of most consumer’s annual income – and therefore consumption of these items does not vary much with good or bad times. So why would someone looking for growth own these stocks during good economic times? A quick comparison of any Consumer Staples Index ETF against the S&P 500 Index will show that S&P 500 Index is up about 80% over the last 5 years, whereas the recommended “Consumer Staples” ETF is up only 37%. If we then compare Standard Deviation between two index ETFs to measure how much more volatile the S&P 500 Index ETF is we will see that not by much: 5 Year Standard Deviation = 15.3 whereas 5 Year Standard Deviation of the Consumer Staples ETF = 12.2.
There is also nothing wrong with buying and holding onto dividend-paying stocks, and it may also feel “safer” to use the income that is produced by the portfolio in retirement as opposed to taking a nibble of the portfolio “principal” every month. But if you check the price chart of a stock that just paid its dividend, you will see that when the dividend is paid … the stock price declines by the amount of the dividend, so in the end, you just indirectly “nibbled” at the principal of your investment portfolio. There is also an argument about control of your portfolio, if you are investing for “Total Return” – YOU have the control of WHEN to sell shares and pull out funds, whereas in a dividend strategy – the board of directors controls when you get the cash that you need … or don’t. What if you sold an investment property and realized a large gain? If you have a substantial dividend-paying portfolio, you will get the dividends on top of the gains you realized on your real estate sale. Having more control in your portfolio will allow for a more tax-efficient investment strategy, because you decide when and what to sell/buy, etc. Also, historically, the total return investing approach has been superior to that of dividend investing – in terms of creating wealth.
Precious metals “hold value” during recessions, and can even appreciate as people search for “safety plays” and can serve as an inflation hedge. This is great, but yet again … it is too little too late when you are a month into a recession and your portfolio is down 50% - which is when these headlines typically pop up. You would have to hold gold just like any other investment vehicle in your portfolio during the good AND the bad times. The problem is that precious metals do not typically do well during good times, and to truly benefit from those times when precious metals shine (pun intended) – you would have to hold a significant amount of it in your portfolio – which would likely underperform equities during periods of economic expansion. If we look at long-term returns, since 1990 S&P500 is up about 1,000% whereas Gold is up around 400%, Silver is up 366%.
Paying down Debt can be a good or a very bad idea, depending on two things; what is the interest rate on your loans and what are the dollars you would use to pay off debt are earning now? The logic here is very straightforward – if the average long-term rate of return on your invested funds is higher than that of your loan – then you are better off keeping your dollars working for you instead of paying off the loans. On the other hand, if the long-term rate of return on your portfolio is lower than that of your loans – you might be better off paying down your debt. There are other factors in making this decision as well, but for the most part, this is how this math problem should be approached.
You might be reading the article and thinking to yourself, “Ok, so you shot down those very popular headlines … so what SHOULD you do during a recession? What should I invest in a recession?”
The answer is …. that there is no straight forward answer to this question, there is no rule of thumb, and there is no paragraph-long advice or “Easy DIY Guide” that so many look for. Those headlines are meant to grab your attention, to get your clicks, so the periodical you are reading could monetize your time spent on their webpage. It is impossible to say that a particular asset class or particular holding will or will not do well during a recession – it all depends on where the recession starts and what asset classes it affects. There are no such thing as “immune” holdings.
The best thing you could be invested in during a recession is … cash. The best thing you could do is to try and avoid a recession by exiting the stock market as early as possible. We designed “Recession Protocol” just for this purpose and have successfully implemented it in March 2020 during COVID Recession.
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