How to Generate Returns During a Recession
Investing your money during a recession can be challenging and stressful. Some investments, such as stocks, can be riskier in a declining market. However, you may be able to achieve steady returns during a recession if you manage your risks by rebalancing your portfolio or using strategies like dollar-cost averaging.
Don’t Abandon Your Strategy
A decline in stock prices may lead you to try to time the market when stock prices are low and falling, hoping that prices will rebound quickly. However, the most effective way to manage your money during a recession may depend on several factors, including your risk tolerance and time horizon, i.e., the time you need to access the funds.
Dollar-Cost Averaging Strategy
Whether you contribute regularly to a 401(k) or an Individual Retirement Account (IRA) or invest in a taxable account through your broker, it may be wise to continue doing so during a recession.
The dollar-cost averaging strategy allows you to invest the same amount continuously, whether the market is trending up or down. As a result, you will buy more shares when the stock price is lower and fewer when the price is higher.
Here is a table showing an example of an investor buying $1,000 worth of shares every quarter for a year:
From the table above, we can see that more shares were bought when the stock price fell, even though the same amount was invested each quarter. Here are the investment results:
Total amount invested = $4,000
Total number of shares purchased = 99 shares
Average share price = $46.25 or (50 + 70 + 40 + 25 = 185) and 185 ÷ 4 = $46.25
The average price paid per share is lower than the initial price due to the bear market. Therefore, if the stock price rises back to $50, the investor will make a profit of $3.75, or 8%, or (50 – 46.25) = $3.75 and (3.75 ÷ 46.25 = .08 × 100 = 8%).
As a result, the dollar-cost averaging strategy can enhance long-term returns if markets rise.
Rebalance Your Portfolio
You can change the balance of your investments when you notice prices dropping. You then rebalance your investments or redistribute your assets back to their original targets.
For example, if your target balance is 60% stocks and 40% bonds, the stock portion will decrease during a downturn in the stock market while the bond portion will increase.
Suppose you started with a distribution of 60% in stocks and 40% in bonds for a total investment of $10,000:
Value of stock portfolio: $6,000 (60% of your portfolio)
Value of bond portfolio: $4,000 (40% of your portfolio)
The stock market declines while the bond market rises, changing your distribution to the following:
Value of stock portfolio: $4,500 (45% of your portfolio)
Value of bond portfolio: $5,500 (55% of your portfolio)
To rebalance, you would sell $1,500 from your bond portfolio and add that amount to your stock portfolio, bringing your portfolio back to $6,000 in stocks and $4,000 in bonds. Conversely, when rebalancing during a growth period, you would sell bonds and buy stocks to return to your target distribution.
The Long View
If you are buying stocks or equity mutual funds, you are likely not going to need to withdraw money from your accounts for at least five to ten years. For this reason, you should not worry too much about short-term market fluctuations.
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If you need to access funds sooner, such as paying your child’s college tuition in the next year or two, you should allocate enough money in bonds or cash before the first year of college. In other words, you do not want to withdraw money from your stock portfolio when the stock market is down, as it can deplete your savings.
Setting aside money for the first years of retirement or college or an emergency fund can provide you with cash when you need it, helping you avoid dealing with market fluctuations.
Don’t abandon your strategy during a recession
Stock prices may be low, but that doesn’t mean you should change how you invest. This approach applies to long-term investors, short-term investors, and retirees.
Note: A recession is not declared until after analyzing many factors. If you plan to sell before a recession starts, you are likely to miss it and lose money.
Long-term investors: If you are regularly adding money to a long-term account, like a 401(k) or IRA, don’t stop during a recession. If you’ve placed most of your money in stocks, don’t follow the performance and sell them. Their prices may decline while bond prices rise. If that happens, you could lose more money compared to staying in stocks. If you have chosen your stocks and funds carefully, you will end up with more money than you started with. Keep going on your path.
Short-term investors and retirees: Even though you may feel uncomfortable…
Source: https://www.thebalancemoney.com/is-it-better-or-worse-to-start-investing-in-a-recession-357892
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