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Investing during a recession can pay off, but only if you can truly afford the expense and fully understand the risks.
Among the greatest risks is the possibility of your investment in the stock market taking a dive during a recession. On the flip side, stocks you buy at a low recession-era price could soar in the months or years ahead.
How do stocks work? On stock exchanges, an investor can purchase shares in a company like Apple, Facebook or Starbucks. If you hold stock in one of these companies, you own a slice of it.
One of the biggest considerations when deciding whether to invest during a recession is your risk tolerance: Would you be OK seeing the value of the stock or another investment swing wildly, or would you lose sleep over the ups and downs of the market? And how much might that volatility harm your finances? Will it endanger your emergency fund or the payment of necessary expenses? Read on to find out whether investing during a recession might be right for you.
Is It Smart to Invest During a Recession?
It can be smart to invest during a recession. But the ultimate answer to this question rests with how much money you can afford to lose, how comfortable you are navigating the investment world and how much risk you can stomach.
In a recession, the stock market is often volatile. Depending on a variety of factors, the market could crash at any moment. As the stock market plunges, so, too, may your investments—at least temporarily—but remember that you won't realize any actual losses unless you cash out.
At the same time, those recessionary pressures pushing down stock values could give you an opportunity to buy shares in a company at a rock-bottom price, eventually leading to a profit if the stock rebounds with the economy. In fact, your stock might gain more value over the long term if you buy it during a recession than during an economic boom.
However, there's no guarantee a stock you buy during a recession will deliver a profit in the near future. It typically takes time for a stock to recover and regain the value that might have evaporated in an economic downturn. And, depending on which industries suffer most during a recession, the company you invested in may never recover and your investment could be wiped out.
If you decide that you can afford to sink some money into the stock market during a recession, it might be wise to visit with a financial advisor for some guidance.
The Risks of Investing During a Recession
As mentioned, choosing whether to invest during a recession should depend on whether you can really afford to do it and how much risk tolerance you have.
First, think carefully and in detail about your financial situation. Do you have enough money saved in an emergency fund? Would dedicating money to an investment harm your ability to cover household expenses or pay your debts? Leaving yourself in a financial bind is rarely worth the possible rewards of investing in the stock market.
Also keep in mind that it's hard to time the market, even for professional investors. Choosing a single moment to invest your money is essentially a guess. And if you guess wrong and then need to pull your money out of the market to meet everyday financial needs, you could end up with a small fraction of your original investment.
Here are good ways to minimize risk when investing in the stock market:
- Diversify your portfolio. Simply put, this translates to not putting all your eggs in one basket. For instance, you likely would want to avoid spending every one of your investment-designated dollars on a single stock. Instead, you might split your money among several stocks or, even safer, a few mutual funds. Diversification is designed to offset losses from some investments with gains from others. It won't necessarily shield you from all losses, but it could cushion the financial blow.
- Invest in index funds. Rather than trying to hit a bull's-eye with purchases of individual stocks, investing in an index fund lets you pick a group of stocks or bonds tied to a market index. These indexes include the Dow Jones Industrial Average and the S&P 500. Index funds tend to be lower-risk options for investing, since they normally enjoy balanced long-term growth and they spread your risk over a variety of stocks and bonds.
How to Get Started With Investing
There's no one approach to investing your money.
Of course, you can try handling investment decisions on your own. The easiest DIY path involves setting up an investment account at a traditional or online brokerage firm such as Charles Schwab, Fidelity, Merrill Lynch and E-Trade. Depending on the type of brokerage firm, you might be able to reach out for professional investment advice.
An alternative is to let a robo-advisor do the work for you. Typically, a robo-advisor automatically makes investment decisions based on your preferences. For a more hands-on (and more expensive) approach, you can hire a personal financial advisor to manage your investments.
No matter which route you chose, here are three types of investment to consider:
- Mutual funds: A mutual fund is a bucket of stocks, bonds or other securities. One type of mutual fund is an index fund, which mimics the performance of the stock market by investing stocks in a certain stock index, like the S&P 500. Overall, mutual funds tend to be less risky than individual stocks. A cousin of mutual funds is an exchange-traded fund (ETF). An ETF involves a basket of stocks or other types of securities. However, it's not identical to a mutual fund. One big difference: A mutual fund can be bought or sold only once during a single day, but an ETF behaves like a stock and can be traded numerous times throughout the day.
- Individual stocks: When you buy an individual stock, you're essentially becoming an owner of a piece of the company. The company's financial performance, combined with market factors, dictate the value of its stock.
- Bonds: A bond is a low-risk investment that's similar to an IOU. You're lending money to the borrower, such as a corporation or government entity, in exchange for a promise that you'll be repaid with a certain amount of interest.
Rather than buying one of these investments individually, you might look at purchasing them through a 401(k) or IRA if you're not already saving for retirement. These investment vehicles are designed to help you save money for retirement, whether that's 10 years or 40 years down the road. Both the 401(k) and the IRA offer tax advantages that individual funds, stocks and bonds don't.
Before settling on any type of investment, you might consider visiting with a financial advisor to set up an investment strategy that's tailored to your goals and designed to minimize risks. But while you can pick up valuable investment insights from a financial advisor, keep in mind that this advice comes at a price. A financial advisor typically charges an hourly fee, a flat fee or a percentage of the assets they're managing. These costs can range from hundreds to thousands of dollars.
The Bottom Line
Investing during a recession can yield profits, but it comes with risks. Buying a stock at a low recession-level price can deliver a big bang for your buck in the short term or long term. But the stock also might never rise above the price you paid, meaning you'll lose money. To improve the odds of profiting from your investments, you should diversify your investment portfolio rather than betting everything on a single stock.
Give careful thought to any investment you make in a recession (or at any other time, actually). Should you use that money to start an emergency fund or pay off high-interest credit card debt instead of buying stock? Can you really afford to invest your money, particularly since you could be laid off from your job because of the recession? Whatever you decide, be sure you're aware of both the risks and rewards.