Financial Planning Fridays #28: Investing During a Recession

Since at least the middle of 2022, there has been constant debate about whether the U.S. economy is in a recession or is about to enter one. The term “recession” can strike fear into the hearts of investors, and for good reason.

Recessions are periods of economic decline, typically characterized by a decrease in economic activity, rising unemployment, and falling stock prices. Because of this the instinct for many may be to sell off their investments during a recession and hold onto cash until the economy recovers. However, history has shown that staying invested in stocks during a recession can actually be the right move.

First, it’s important to understand that the stock market is not the same as the economy as a whole. While the economy may experience a downturn during a recession, the stock market is not necessarily a reflection of the entire economy. In fact, stocks sometimes recover well before the broader economy does.

Another reason to stay invested in stocks during a recession is the potential for buying opportunities. When stock prices fall, many investors may panic and sell off their holdings. However, for those with a long-term investment strategy, like us, a market downturn can present a great opportunity to buy stocks at lower prices.

Finally, it’s worth noting that stock prices tend to be forward-looking. That is, the market is not just a reflection of current economic conditions, but also of expectations for the future. During a recession, many companies may struggle in the short term, but the market may already be factoring in expectations for future growth once the economy begins to recover. By staying invested in stocks, an investor can potentially benefit from the market’s long-term outlook and position themselves for future growth opportunities.

Let’s look at the data from the 13 U.S. recessions since World War 2:

The average length of a recession has been ten months ranging from two months up to 18 months long.

This chart shows the annualized return of an investment made in the S&P 500 right at the start of each of those recessions:

The average annualized return was about five and a half percent during the actual recession. Not bad and probably not a reason to change your long-term strategy.
Now let’s look at the returns over slightly longer time frames:

We calculated the returns based on an investment made in the S&P 500 the month the recession started. The cumulative returns are as follows:
• One year after the start of a recession: 6.7%
• Two years after the recession started: 24.6%
• Three years after the recession started: 38.2%!

Looking at this, it not only makes sense to hold your investments through a recession but to add to them if you can. Once again it is amazing how the market continues to move up over time even through temporary economic crises, uncertainty and recessions.

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