Rule of Thumb in a Recession

 Rule of Thumb in a Recession

With the rising interest rates, high inflation and volatile market, many have started to feel the pinch as economic headwinds grow stronger. Talks and discussions about a possible recession in 2023 are everywhere in the market and investors are getting more and more anxious. 

No matter how turmoil the market gets, it is important to remember that recessions will not last forever and as quoted from the great Abraham Lincoln’s favorite saying, “This too shall pass”. With enough patience and positive action, investors can ride out the turbulence eventually.

During a recession, the volatility and uncertainty in the stock market may cause panic selling which can result in significant losses for investors when they are selling at a low price and miss out on potential gains when the market recovers. Instead, it is recommended that investors maintain a long-term perspective and avoid making hasty and emotional decisions based solely on short-term fluctuations in the market. According to AHAM Capital, the shortest bear market was experienced in 2020 at the onset of the COVID pandemic where the MSCI World Index plunged by over 33%. However, the recovery was equally swift and rapid too where the global equities rebounded back all its gains in over a month and have climbed to new highs since.

While it is tempting to buy during the dip and sell high, it is actually difficult to predict the future market movements as when the market will hit its highest or lowest point. In fact, many studies have shown that even professional investors often fail to consistently beat the market by timing their trades. The wiser strategy is to adopt a DCA approach by investing in fixed sums in regular intervals regardless of market conditions. This will help to lower the purchase price of the investments over time by taking advantage of market dips as well as reduce the risk of bad timing. Many financial advisors and experts also recommend holding onto investments. This strategy is often referred to as “buy and hold,” and it’s based on the idea that the stock market tends to rise over time, despite short-term fluctuations.

Moreover, staying invested and maintaining a diversified portfolio can help investors weather the storm and position themselves for potential growth when economic conditions improve. Historical data has shown that investors who hold on to their portfolios and invest continuously do better than those who cashed out during dips. Having and maintaining a well-diversified portfolio is also one of the best recession-proof investments there is during a market downturn. During difficult times, certain sectors and businesses are impacted more than others as demand declines and borrowing costs rise. Hence, a well-diversified portfolio should comprise different sectors and regions that would allow investors to better hedge their bets. However, it is essential to keep in mind that one should only invest the extra money not needed for several years where at least 6 months’ worth of emergency fund has been set aside.

Besides setting aside emergency funds, investors may also need to recheck their risk profile as many uncertainties can take place during a recession i.e. getting pay cut or being laid off from a full time job. In this case, one’s tolerance for volatility may no longer be the same as before, thus, rechecking the risk profile for all investments is a necessary step to take during a recession.

Under this circumstance, it is wiser to load up more defensive assets or funds such as bonds and dividend-focused investment to buffer and weather the volatility in the market. It may be useful as well to set aside cash in the portfolio that can help to insulate against losses. The rule of thumb is to know one’s risk tolerance and apply strategies to withstand the market pullbacks.

Last but not least, after the portfolio has been tailored towards risk profile and diversification, the next step forward is to wait and do literally nothing. Stick to the plan and acknowledge that some things are just not within our control. The market will have its high and low, but what’s important is to keep a cool head and avoid giving in to impulses when things get volatile. Ultimately, it is essential to keep in mind that investing is a game that favours the patient and bold.