The UK economy shrunk by a record 20.4% in the second quarter of 2020, plunging the country into a recession for the first time in 11 years, according to figures from the Office for National Statistics.
For many investors, the normal reflex action on hearing that we are in a recession is to become more conservative. But is it wise to completely hold off any kind of investing during a recession? Or are there some safe investment opportunities to take advantage of when the market is in a downturn?
Let’s explore this further.
What happens during a recession?
To make sense of whether it is safe to invest during a recession, it is important that we first understand what usually happens when a recession hits.
A recession has several negative economic impacts. One is a rise in unemployment. We are already experiencing this in the UK. According to the ONS, the number of people in work fell by 220,000 between April and June.
Another affected sector is housing, where prices typically fall, sometimes quite drastically. The Centre for Economics and Business Research, for example, predicts that house prices could fall by as much as 14% next year as the country continues to grapple with the effects of the coronavirus pandemic.
Though interest rates may go down during a recession, as the government takes action to mitigate the economic decline, you may find it harder to get approved for a loan as creditors tighten their belt on borrowing due to fears of not being paid back.
This means an increase in minimum credit score requirements, higher deposit requirements for mortgages and even the discontinuation of several types of loans all together.
Savings interest rates might also go down during a recession to encourage more spending.
A recession does not spare the stock market either, with many companies seeing a drop in their share prices.
Consumers can also expect a rise in many commodity prices during a recession.
Should you invest during a recession?
It might seem counter-intuitive, but a recession actually presents a prime investment opportunity for savvy investors.
However, before you even start thinking of investing in a recession, there are important rules to observe. First, only consider investing if you have a healthy emergency fund or sufficient savings to fall back on in case you encounter financial hardship yourself during the recession.
Secondly, only invest money you won’t need any time soon. Nobody knows how many years it will take for the market to recover from a recession.
Where should you invest?
The stock market is an excellent place to invest during a recession. If you are the kind of investor whose approach entails looking for ‘the right time’ to invest, there is perhaps no greater time than now.
Many companies’ stock tends to lose value during market downturns, leading to a drop in share prices. By buying shares when prices are low, you can get more for less money. You also stand to gain greater returns once the economy recovers and share prices rise again.
However, remember that during a recession, you have to play the long game. The ride will undoubtedly be a bumpy one. But even when things seem to be getting worse (as they often do during a recession), don’t be spooked into panic selling your investments.
If you give your investment sufficient time to ride out the downturn, the market is destined to bounce back, just as it has throughout history. You will reap the rewards then.
Unfortunately, this means that if you are the kind of investor who consistently invests hoping to make quick gains in a short span of time, investing during a recession might not be a good move for you.
How should you invest?
Before you invest, you need to conduct sufficient research on each company you’ll be investing in. Before you buy a company’s stock, ask yourself questions such as:
- How long has the company been in business?
- Does it have a solid history of growth and a stable earnings record?
- Does it have a previous history of successfully riding out a market crisis?
- How has the industry that the company operates in been affected as a whole?
- What are the experts saying about the company?
Though there are no recession-proof investments, blue chip stocks are a relatively safe bet when thinking of investing during a recession. They might not be completely immune to market downturns, but blue chip companies have deep pockets that allow them to outlast the difficulties.
It can be daunting to even think of investing during a market crisis. But as seasoned investor, Warren Buffett once said, “Bad news is an investor’s best friend.” A recession can be a prime time to invest – as long as you take precautions to protect your financial wellbeing.
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