Is It Risky To Invest During A Recession

Recently, while I was on a plane,  I met a fellow Singaporean. While chatting, we shared about our work and when I told him that “I teach people how to start investing”, he said immediately “It is not a good time to invest now right?”

“Why?” I asked.

“Isn’t it too risky to invest during a recession?”

This comment piqued my curiosity. “Why do you say that?” 

“The stock markets are all down. You will only lose money.” 

“Do you invest?” I asked. 

“No I don’t know how. But I bought shares in NIO.” (for the uninitiated, this is the stock ticker for a Chinese electric vehicle company which is listed in the U.S.)

NIO’s past 5-year share performance. From the peak in Jan 2021 to end of 2022, the company had lost about 80% in share price. (Chart Source: Yahoo Finance, 07 Mar 2023). 

“Oh wow, that’s quite a volatile pick for someone who don’t know how to invest.” I commented. 

“I heard from my friend that the stock is good and I bought it sometime in 2021. I lost money but luckily, I didn’t put in a lot of money.”

Warren Buffet’s classic quote popped up immediately in my mind.  

“Rule No. 1: Never lose money.

Rule No. 2: Never forget rule No. 1.”

It was clear to me that this new friend I met, with all due respect to him, was indeed not investing. It was a gamble he had on NIO…and he lost. 

Also, one of the top mistakes that newbies make is to buy shares based on “hot tips” from well-intentioned friends and family, who could possibly know no better about the stock than the next guy on the street.   

So to answer his question “Isn’t it too risky to invest during a recession?” I would say “It depends.”

First, let’s address what a recession is. A recession has been technically defined as two consecutive quarters of decline in real Gross Domestic Product (GDP). GDP measures the  combined value of all the goods and services produced in an economy. 

So what happens during a recession? Slow down in the economy, rising unemployment, increasing bankruptcies, defaults and foreclosures, lower company profits, more volatile financial markets etc. These are all common indicators of a recession. 

Source: NBER

The U.S. has experienced 34 recessions since 1857 according to the National Bureau of Economic Research (NBER), varying in length from two months (February to April 2020) to more than five years (October 1873 to March 1879). The average recession has lasted 17 months, while the six recessions since 1980 have lasted less than 10 months on average.

Now that you understand a little more about recession, here are

5 Questions to ask before you invest during a recession:

1. Do I Have My Emergency Fund In Place? 

During a recession, job losses, pay cuts, bankruptcies (of customers and suppliers), poor financial results are common. To avoid the unfortunate situation that your salary or business profits are affected by a recession, you will need to have an emergency fund. Don’t be caught off guard.  

An emergency fund is 6-12 months of your monthly expenses. This fund is for you to tap on in case you lose your income or if you need money for some emergency purposes. 

Make sure you have your emergency fund is in place before you start to invest. The money that you use for investing should not be money that you may need to tap on during a recession. 

2. What Is My Investment Time Horizon?

How long can your money stay invested? Do you have other short-term goals where you will need your cash back, say in the next 1-2 years? If yes, stick with more safe bets like fixed deposits and cash products. 

If you have a longer time frame of more than 5 years, a recession is the perfect time to  build your investment portfolio.

Chart Source: Yahoo Finance. S&P500 Index performance between 1997 and Mar 2023.

Think about it. As mentioned earlier, there had been 6 recessions since 1980 and on average these recessions lasted no more than 10 months. If your money could stay invested for more than 10 months, would you like to buy your long-term stocks at a low price (e.g. during a recession)? Or would you wait until the economy and market sentiments are recovered and bullish and start chasing the stocks at a high price? 

One of Warren Buffett’s famous quote is

“Be fearful when others are greedy and greedy when others are fearful”

and

“The best chance to deploy capital is when things are going down.”

So, are you a young professional who is just starting out your career and has a long investing time frame ahead of you? Or are you someone who is near retirement and will need your funds pretty soon for your retirement lifestyle?  

3. What Is My Risk Profile?

That leads me to the next consideration. When you have a long time frame ahead of you,  your ability to take risks is generally higher than someone who is nearing retirement age.  

Understanding and investing in line with your risk profile will help you to sleep better at night, and through a recession. 

4. What Is My Investment Strategy

Do you have an investment strategy? Or is your portfolio made up of random stocks which you had picked up overtime and you are clueless about what you should do with  each stock position? 

Based on your risk profile, is your portfolio more suited to a dividend portfolio, to create passive income over time? Or one of growth, which is to take higher risk to create more capital appreciation over time.

Having an investment strategy will allow you to make smart financial decisions during a recession, by picking up suitable stocks at a good price.

5. Do I Manage Risk In My Portfolio? 

Do you understand the investment products in your portfolio? 

Do you know the ongoing fees and costs of the investments in your portfolio? 

Back to the words of the investment guru, Warren Buffett

“Risk comes from not knowing what you are doing.” 

When you invest your hard-earned money, make sure that you understand what you are buying into and that the products are suitable for your risk profile. 

If you don’t know the difference between a stock and a bond. You can always invest in a financial education or a finance coach to help you navigate your investments better.  

“The most important investment you can make is in yourself.” ~ Warren Buffett

Know how much risk you are able to take. Never lose more money than you are willing to and there are strategies to ensure that.  

In the end, what you can do during a recession is to focus on what you can control - why you invest, how you invest, what you invest in.  

Let go of what you can’t control - economy, stock price movements, interest rates movement etc. 

You cannot stop a recession but you can decide what you are going to do during one.