Why a recession can be good news for investors

Investors who prepare for recessions needn't live in fear of them.

  • By Coryanne Hicks,
  • U.S. News & World Report
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Few things send investors fleeing for the stock market door faster than thoughts of an impending recession. But recessions are not the end-of-world catastrophes many believe them to be.

In fact, recessions are nothing to be feared – and can even be good for long-term investors who play their investment cards right.

The economy's natural tendency is to grow because it's fueled by a constant supply of people who all want to do a little better, says Kate Warne, investment strategist at Edward Jones in St. Louis. Consumers want higher incomes to be able to buy more things, and companies are constantly trying to increase their earnings to claim a larger market share. With these logs to stoke the economic flame, the economy should keep growing and growing.

"But of course there are always things that disrupt growth" and trigger periodic recessions, Warne says. Typically recessions occur every four years on average, and they come with no warning. But this doesn't mean you should live in fear of impending recessions.

"As an investor, assuming your portfolio is diversified and you are in the proper allocation for your life stage, risk tolerance and investment objectives, there is no sense worrying about a recession," says Lacey Cobb, director of portfolio management at Personal Capital. "It is not something you can control, and a future recession is inevitable."

What's more, recessions can actually be good things for the economy and well-prepared investors.

Why investors shouldn't fear recessions. "Periodic recessions are a healthy part of the economic cycle in that they tend to flush out zombie companies, reset asset prices and reestablish efficiency," Cobb says.

Historically low interest rates have made it possible for "zombie companies" that continue to operate despite being unable to pay off their debts to cling on longer than they should.

"These zombies act as a drag on the economy by sucking up resources to stay afloat instead of allocating capital more efficiently elsewhere," she says. "It usually takes a recession to force (them) into bankruptcy, as liquidity dries up, paving the way for improved productivity in the economy."

Recessions also often come with bear markets wherein stock prices fall by 20% or more. To most investors, this is not seen as a good thing, but consider: When stock prices fall, it's called doomsday but when the price of bread drops 20%, it's called a sale.

The drop in stock market prices that typically follows a recession can be a major boon for long-term investors starting out, says Monica Sipes, senior wealth advisor at Exencial Wealth Advisors. It just means equities have gone on sale.

"In some rare cases, equities have been 30% to 50% cheaper during a recession than they were just a few quarters prior," Sipes says. So rather than running in fear from price declines, buy an extra loaf of stock while it's on sale.

Adding to your investments at lower prices translates into higher long-term returns, Warne says. Over the long term, the stock market rises. So the lower prices recessions bring can actually help you achieve your long-term goals.

How to survive a recession. The trick is to make sure you're invested in such a way where you aren't forced to sell investments when prices are low and, if anything, can add to your portfolio, Warne says.

If you're near retirement or when you'll need to sell your investments, put money into a ladder of short-term fixed income investments or certificates of deposit (CDs) so you can spend from that portion of your portfolio rather than needing to sell stocks, she says.

Even if you won't need money from your investments in the near future, you should prepare emotionally for a recession.

"When stock prices fall everybody will tell you they're only going to fall further, so (selling) will feel like the right thing to do," but it's the wrong move, Warne says.

"By the time we know we're in a recession, it's usually close to the end," she says. So while you may think you're selling before the drop, you're more likely selling right before the rebound.

"The hardest part for investors when it comes to a recession is resisting the urge to react to market moves," Cobb says. "Behavioral mistakes are the biggest portfolio killer for investors, not the market moves themselves."

Avoid the impulse to abandon your investing strategy during downturns by making sure you're invested appropriately for your goals and risk tolerance.

"Ask yourself: Can I handle a 25% drop to my capital over the short term?" Sipes says. "If the answer is no, then you probably should be acquiring safer assets alongside an equity portfolio."

"Usually, the best thing you can do for your portfolio in a recession is leave it alone," Cobb says. "There will be investing, rebalancing and tax loss harvesting opportunities, but overall your strategic allocation should not change in a recession."

Sipes likes to think of an equity portfolio as a collection like a set of comic books or baseball cards. "The difference is that you can see the monetary value of your portfolio every day," she says. "Without any immediate plans to monetize, know that the worth of your collection will fluctuate but ultimately grow more valuable over time."

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