Investors and their finances can feel uncertain during a recession or economic downturn. Usually, as the economy slows down, stock prices decline, and workers worry about losing their jobs. However, it is also a great time to invest. In this regard, there are some essential things you should know about investing in stocks during a recession or market downturn.
Market downturns
It is important for long-term investors to anticipate market downturns as they have been occurring throughout history, with 22 bear markets (i.e., declines of 20% or more from a recent high) observed since 1929. The severity of these downturns has varied dramatically. During some economic downturns, prices can drop and then rebound quickly. This was the case at the beginning of 2020 when investors were worried about the effects of COVID-19. However, other downturns can take a longer time to recover.
Market downturns provide opportunities for long-term investors. When a recession occurs, stocks tend to fall as investors expect lower earnings and become concerned about the economic outlook. If investors only buy stocks during good economic times, their investment record will likely be mediocre. As the renowned investor Warren Buffett has remarked, “You pay a very high price in the stock market for a cheery consensus” because the future is never clear.
One of the best things you can do as an investor is to prepare for market downturns. This can have a substantial impact on your investments over time.
Impact of investing during a recession
According to Chris Davis, the chairman of New York’s Davis Advisors investment management firm, his grandfather used to say, “You make most of your money in a bear market – you just don’t realize it at the time.”
A study conducted by Davis Advisors showed the different reactions of three hypothetical investors who had invested $10,000 in an S&P 500 index fund at the 2007 market peak when the global financial crisis hit in 2008 and 2009, causing a decline in stocks.
- Nervous investor: They sold all their stocks when the market was low on March 9th, 2009 and put their money into cash.
- Patient investor: They kept their stocks even when the market was declining, choosing to stay invested.
- Savvy investor: On March 9, 2009, I took advantage of the market downturn and invested an extra $10,000 in stocks.
The three investors had different reactions, which resulted in significantly different outcomes. The nervous investor ended up with $5,138 at the end of 2022, while the patient investor had $33,420. The savvy investor, who added more investments when the market was low, ended with a remarkable $108,119 at the end of 2022.
Looking back with hindsight, the savvy investor’s approach may seem obvious. However, it may not have appeared that way at the time. During a recession, the media is inundated with stories about the poor state of the economy, and experts speculate on whether it will deteriorate further. Nonetheless, by investing during a downturn, even if not at the market’s lowest point, one can still enhance their long-term returns.
How to buy stocks during a downturn
There are several ways to increase your stock investments during a market downturn.
Rebalance your portfolio
To enhance your stock holdings during a downturn, consider rebalancing your portfolio. As prices fluctuate, the weightage of your portfolio also shifts. If the prices of stocks fall, their weightage in your portfolio reduces if other investments like bonds have dropped by a smaller margin. Bringing your portfolio allocations back to your desired levels or increasing your stock allocation can potentially lead to substantial returns when the downturn concludes.
Increase retirement account contributions
To increase your exposure to stocks during a market downturn, consider increasing your contributions to retirement accounts like a 401(k). You can opt to have more money deducted from your paychecks, which will be added to your 401(k). It is possible to alter your contribution amount in the future if the market situation improves or your financial circumstances change.
If you have already reached the maximum contribution limit for your 401(k), you may want to consider putting money into a traditional or Roth IRA. These accounts offer a wider range of investment choices while still providing similar tax benefits as 401(k) plans.
Buy stocks directly in a brokerage account
You can purchase stocks via a brokerage account and contribute any amount you wish. This method offers greater investment options and flexibility for withdrawals. Although you may withdraw money from a brokerage account at any time, you’ll be liable for taxes on any earnings, as opposed to retirement accounts, where early withdrawals typically incur penalties.
Bottom line
Investing more money in the stock market during a recession can help you achieve your long-term investment goals and increase returns. Despite the negative news that comes with a downturn, buying stocks at a low price can be rewarding in the long run. You can consider increasing your contributions to retirement accounts, rebalancing your portfolio by investing more in stocks, or buying stocks directly from a brokerage account to take advantage of low prices.