One of the biggest concerns that people have when they start investing money is this…what should I do if we enter a recession? This is an incredibly common concern and, luckily, one that has a few concrete answers.
While a recession is never an ideal scenario there are a few ways that you can make sure your money is protected. If you’re comfortable taking on some risk, there are even ways that you can make money during a recession.
Let’s take a look at where you should put your money during a recession.
Make sure you are diversified
The most effective way to protect your money during a recession is to take the necessary precautions before the recession actually starts. In this sense, it’s a little bit like putting on a seatbelt when you get into a car. Obviously, you have a lot of faith that the driver isn’t going to crash (if you didn’t then you wouldn’t even get in the car) but it’s still a good practice to be careful anyway.
However, if you try and wait until you’re in the middle of a crash to try and put your seatbelt on then you’re probably going to have a rough time. In that same sense, if you wait until we’re in the middle of a recession to start scrambling to protect your money then you’ll be in for a bumpy ride.
With investing, diversifying your portfolio is the equivalent of putting on your seatbelt. If you’re not familiar, diversification is defined as a risk management strategy that mixes a wide variety of investments within a portfolio. In simple terms, this means buying a wide range of assets in case one fails.
For example, if you invest all of your money into one stock then you will be completely out of luck if the price of that stock tanks. However, if you invest money across ten different stocks then you will be protected if one stock declines because the others are likely to go up in value.
One of the best ways to make sure that you are diversified is to purchase shares in index funds. Index funds are like baskets of stocks that mimic an entire range of stocks, such as the S&P 500 index. This way, instead of trying to identify singular stocks to invest in you can just invest in the entire stock market. To take it a step further, most investors will usually diversify their money across different assets.
If you find yourself in the middle of a recession and it’s too late to try and diversify your money, then the next best option is to just hold cash. This is because, as strange as it sounds, recessions are a great time to invest money. Think about it…
Every year during Black Friday almost every store puts on a huge sale and people rush to buy products at a discount. Well, during a recession, almost all assets will drop in value. This makes it a great time to rush and buy stocks that are essentially on a discount. As the famous investor Warren Buffet puts it, “Be cautious when others are greedy and greedy when others are cautious”.
If you are tentative to buy stocks during a recession out of fear that they will never rebound then you might want to consider safer assets.
Commodities are things like oil, precious metals, grains, beef, or natural gas. When we say to buy commodities, we don’t mean that you should head to the grocery store and buy five pounds of beef. Instead, you can invest in exchange-traded funds that track the spot prices of these assets.
These types of assets, especially precious metals like gold or silver, are usually considered safe havens during times of economic uncertainty. This is because all of these assets have real-world use. Since people still need to buy oil and beef, even during a recession, their prices are slightly less volatile than stocks.
Start playing offense
If you are more interested in actually making money during a recession, instead of just not losing what you have, then there are still two more strategies that you can explore. However, keep in mind that both of these are very risky and should only be attempted with money that you are comfortable losing. Let’s take a look:
- Short a stock market index – In investing, “shorting” a stock is trade you can make when you think that stock is going to go down. To short a stock, you borrow someone else’s stock and then immediately sell it. You then wait for the price of the stock to drop and then buy it back so you can return the stock you borrowed. The difference between what you sold it for and what you buy it back for is your profit. This will allow you to profit from declining stock prices but keep in mind that it is incredibly risky. If the price of the stock does not go down as expected then you will quickly be in a lot of trouble.
- Buy put options on a stock market index – Buying a put option on a stock market index is a slightly less risky way to make money off of declining stock prices. A put option is a contract you buy that allows you to sell a stock at a predetermined price. For example, if you have a put option contract that allows you to sell a stock at $100 and that stock’s price declines to $80, then you’ve made a profit of $20.
Both of these strategies will allow you to profit in the short term if the stock market continues to decline. However, doing this is also a little bit closer to gambling than investing.
We hope that you’ve found this article valuable when it comes to understanding where you should put your money during a recession. If you are interested in learning more, please subscribe below to get alerted of new articles as we write them!