Recessions are a part of the standard economic cycle. Even though recessions can lead to market crashes, bear markets, and corrections, they can also create good investment opportunities. Investing during a recession leads to fewer losses, leaving more capital to reinvest at lower prices.
In today’s article, we will help you find the best way to navigate an economic downturn and find the best recession-proof investment. Therefore, we will cover:
- What is a recession?
- What to invest in during a recession?
- The best recession-proof investment strategy.
- How to create wealth with the Infinite Banking Concept even during a recession?
Let’s dive in!
What Is a Recession?
Before finding a way to invest during a recession, it is essential to understand what a recession is.
A recession is a significant, prolonged, widespread economic activity downturn. It usually lasts six months or more, and the standard rule of thumb is that two consecutive quarters of decline in a country’s Gross Domestic Product (GDP) constitute a recession.
Economists and the National Bureau of Economic Research (NBER) characterize a recession as an economic contraction starting at the peak of the expansion and ending at the low point of the ensuing downturn.
Even if it may last for only a few months, the economic recovery can take years. Many economic theories are trying to explain how and why the economy might fall into a recession. These theories are often based on financial, economic, or psychological factors.
Many professionals focus on economic changes, including structural shifts in industries, as the most significant. For instance, sustained growth in oil prices caused by a geopolitical crisis can raise costs across the economy, and new technology may briskly make entire industries out-of-date. A recession is a plausible outcome in both cases.
We experienced the COVID-19 epidemic in 2020 and the economic shock that followed and caused a recession. However, it is not rare that economic shock merely accelerates the start of a recession that would have happened anyway due to other economic factors and imbalances.
Other theories prefer to explain recessions as dependent on financial factors. They focus on credit growth and the accumulation of financial risks during the stable economic period preceding the recession, the contraction of credit and money supply at the outset of a recession, or both.
Monetarism is an example of this theory, which associates recession with insufficient growth in the money supply.
Theories based on psychological effects target the over-exuberance of economic booms and the deep pessimism rampant during downturns. They find this as an explanation for why recession occurs and persists.
Experts are warning that a recession looks ”inevitable” as the Federal Reserve scrambles to combat surging inflation by raising interest rates at the fastest pace in the last 28 years.
A drop in economic output, employment, and consumer spending is observed during the recession. Additionally, interest rates are likely to decrease due to the central bank (the Federal Reserve in the U.S) cutting its benchmark rate to help the economy.
The tax revenues are tailed off, which causes the government’s budget deficit widens. Simultaneously, spending on unemployment insurance and other social programs increases as more people qualify for support and benefits.
What to Invest in During a Recession?
You can approach investing during a recession from a long-term and short-term perspective. If your plans are long-term, you must be ready that your long-term portfolio can weather unexpected recessions and volatility.
This can be done through strategic asset allocation. Some professionals think it is crucial not to let fear sabotage your long-term strategy.
As Sam Stovall, chief investment strategist at CFRA Research, says, ”If you are a nervous Nelly, then simply remind yourself of the speed with which it’s taken for the market to get back to break even.”
On the other hand, in the short term, you should be looking to move part of your portfolio into recession-proof investments when the probability of a recession is high.
Now, let’s see why a recession can be profitable for investing. Economic downturns usually lead to lower profits for most leading business firms and high-quality companies (like Coca-Cola). Due to that, it only takes the expectation of recessions for a stock market crash or correction to occur. However, investing during recessions can also be beneficial.
For example, the great recession in 2008 seemed like the end of the world for many investors and people. Still, it was a lifetime buying opportunity ahead of a ten-year bull market.
The sharp declines in stock prices during a crisis or recession may present good investment opportunities. There are several other reasons why recessions can create fantastic buying opportunities. High-quality stocks mainly trade at a premium, and the only chance to buy them with a margin of safety is during recessions.
In addition, the field of behavioral finance shows how investors can be illogical. They make mistakes that increase in periods of bear markets and rise of market volatility. This also creates better opportunities for investing. Even the best business firms gain market share during recessions if their competitors are cash-strapped.
Defensive in their name refers to defending an investment portfolio against losses.
Defensive stocks are designed to perform consistently even during economic decline periods when the other equities are tumbling. However, they don’t offer tremendous growth potential.
The consumer staples sector is one of the most prominent defensive sectors. It involves companies like Procter & Gamble that make hygiene products, detergents, and other household products. Like an extension of the consumer staples sector are healthcare companies.
Insurers, pharmaceutical companies, and healthcare providers are all companies that have little exposure to economic cycles.
However, this sector usually doesn’t see the rapid growth that others do, like consumer discretionary – household goods that are not needed but wanted, such as apparel, luxury items, and restaurants.
So, the best thing to do is to invest in companies with low debt, strong balance sheets, good cash flow, and industries that historically do well during tough economic times.
- Stability. This is why many investors decide to invest in them during recessions. Padding a well-diversified portfolio with these predictable performers can defend against sudden swings in the stock market.
- Low-risk. A defensive stock is often a choice of investors who prioritize their wealth against loss. For them, saving what they have is more important than earning more during economic uncertainty.
- Outperformance in periods of economic decline. These stocks are more beneficial than other cyclical ones when the economy drops. It provides a balance to losses experienced by the growth stocks in recessions.
- Low-growth. These stocks rarely experience rapid growth. They can help you preserve value, but you’re probably not going to get rich.
- Often overvalued. Since most people know the stability and low risk of these types of stocks, many choose them as a recession-proof investment. It can lead the stock to take on an artificially inflated value during an economic downturn.
- Underperformance in periods of economic growth. As we mentioned, a recession is only temporary, meaning the time of growth will come again. During that time, holding too many defensive stocks can hurt your portfolio.
Recession effects are entirely different from the effects of inflation on stocks. Stocks with decent dividend yields and high dividend cover rations can be very efficient recession-proof investments because they give us a cushion even if the stock price falls.
Firstly, companies that pay solid dividends are cash-flush, meaning the risk is lower.
Further, investors are looking for the best return possible during recessions. A passive income in the form of a dividend yield of 2% or 3% is more beneficial than a growth stock with a decreasing share price.
As a result, we have that high-quality dividend stocks can perform well during a recession. However, positive, sustainable cash flows must always support an attractive dividend yield. It would be better as the dividend cover ratio is higher because there is a smaller chance of the dividend being cut.
Value stocks are considered a recession-proof investment because they have limited downside. They are priced closer to their intrinsic value, while growth stocks and momentum are priced for growth. People can use a process called dollar-cost averaging and invest a set amount at regular intervals when the stocks are cheaper and can afford more.
Besides their potential upsides, value stocks are riskier than growth stocks because of the stock market’s skeptical attitude toward them. To turn profitable, the market must alter its perception of the firm, which is considered riskier than a growth entity developing. Due to this, a value stock is usually more likely to have a higher long-term return.
ESG investing, also referred to as ”socially responsible investing”, ”sustainable investing”, and ”impact investing”, prioritizes optimal social, environmental, and governance factors or outcomes.
The basic idea is to make investments considering the environment, global economy, and human well-being. ESG investing is based upon the growing assumption that the financial performance of organizations is increasingly affected by social and environmental factors.
There are some solid arguments for following ESG investing during a recession. We have evidence that management teams that take ESG issues seriously remove risk from their companies.
Investing in a recession encompasses moving to assets with lower risk, and these companies tend to outperform. Therefore, stocks with high ESG scores may be a more recession-proof investment than other stocks.
ETFs With Short Exposure
Usually, you buy stocks and sell high later. But, going short reverses that order. A short seller borrows stock from a broker and sells that into the market. After that, they hope to buy back that same stock at a lower price and return the borrowed stock to profit from the price difference.
So it’s not surprising that short-selling individual stocks are shown to be very profitable and have high risks. The majority of shorted stocks are vulnerable to bear market rallies.
- Profit on a stock’s decline. They help investors to profit from the drop in stock. Short stocks provide another tool to support investors making money when they discover an overvalued stock.
- It can be used to hedge a long portfolio. Investors can profit when the market declines if they have a high-risk tolerance. They can also sell their profitable short positions for cash and add to their long posts at decreased prices.
- Total losses. Since the stock an investor has shorted can keep rising, their risk is theoretically uncapped. People could lose more money than they’ve put into the trade.
- Complicated to make money. The stock market tends to go up over time. Therefore, short sellers face a situation already set up against them in the long run.
- Additional costs. Investors with short-selling stocks must pay extra fees to keep short trade – the margin loan, the price of borrowing, any dividends paid, and much more.
Are bonds potentially the best way to protect your finances during a recession? Well, no. Some bonds can be safer, while others not so much.
Bonds are loans from investors to companies and governments and are usually broken into three categories: corporate bonds, municipal bonds, and treasury securities.
Treasury bonds are a traditional option for investors because they carry the highest credit rating and benefit when central banks cut interest rates. Still, past performance is no guarantee of future results.
Many professionals hold that bonds are a safer alternative to stocks. It is based on the fact that stock market declines often accompany recessions, so it makes sense that investors would seek bonds.
However, it doesn’t mean that you should strictly invest in bonds. And it depends more on your investment goals and current financial position than on the state of the economy.
Bonds tend to be less volatile and generally outperform stocks during a recession. Still, bonds don’t eliminate the chances of losing your money. Remember, a bond is a loan, so that bond issuers can default on their loans just like other borrowers.
You should always have cash in savings accounts – old but gold way. There are numerous reasons for this:
- Cash will still generate a small return as compound interest accumulates.
- Cash will lower the portfolio’s volatility, giving you peace of mind and preventing irrational decision-making.
- Available cash will help you pick up bargains when the correction slows.
And if you don’t have a healthy emergency savings account, it should be your priority before choosing other investments.
The Ultimate Way to Invest During Recessions
The Infinite Banking Concept or over-funded life insurance is an investment strategy practiced by the wealthiest people in the country. Over-funded life insurance uses a tried-and-true system to grow wealth while providing access to liquid cash.
The concept is quite straightforward!
The first step is to store money inside a whole life insurance policy. One of the benefits of whole life is that it has two components: the death benefit and savings in which cash value accumulates.
Whole life survived the Great Depression, a global pandemic, and will outlast any future financial crisis. Whole life isn’t tied to the stock market and has a contracted minimum interest rate.
A whole life policy is perfect for Infinite Banking Concept because it allows you to access the cash at any point and use it for any purpose. There are no restrictions! You can do whatever you want or need – supplement retirement, fixed income, family vacation, or investment in real estate; there is no limit.
Furthermore, there is no risk at all. Unlike traditional banks that do not have to store your money in the vault beneath the building, insurance companies must have a dollar in assets for every dollar they lend. The insurance company must guarantee the product they’re selling – the death benefit and to do that.
They invest your money in high-interest loans to the government. The money is given back to the owners of the business – policy owners, through dividends. And we know that dividends can lead to stable cash flow even during recessions.
To conclude, the Infinite Banking Concept is the way to invest regardless of the economy’s situation and the global financial crisis because we have complete control over accumulating capital in our assets. This is especially beneficial for people that tend to be long-term investors.
The basic idea is to copy the traditional banking concept and become your own banker. Instead of conventional banks profiting from your fees and additional charges, you are getting wealthy!
With the Infinite Banking Concept, you have guaranteed liquidity and earn stable returns even when the economy is unstable. In addition, you also have a safe space to stash extra money.
So, what’s the conclusion? Even though we have many options in the market for investments during recessions, neither is perfect. Whether a potential gain is too low or there is too much risk.
But, the Infinite Banking Concept is the ultimate way to beat any economic uncertainty because it has both – it is safe & stable, and you can build wealth. On top of that, it is straightforward to use.