- It is possible to make money in a down market. You just have to be more strategic with your plans.
- Avoid speculative stocks. Instead, invest in high-quality companies.
- Consider selling options and investing in actively managed funds to earn a decent return during a weak market.
As the fear of recession grows, more investors wonder how to recession-proof their investments. Is there a way to not lose money in a down market? Are some investments better than others?
Here is what you need to know to protect your wealth during a weak economy and declining stock market, as well as how you can potentially grow your wealth.
Investing comes with risk
It’s important to understand that the only way you can remove 100% of the risk of losing money when investing in the stock market is not to invest at all. When you purchase an investment, whether it’s a stock, bond, mutual fund, or exchange-traded fund, there is the risk of it going down in value.
While you cannot remove this risk, you can reduce it by investing strategically. Read on for guidance on the moves you can make to keep your money safe and grow it, even if the stock market isn’t increasing.
With that said, here are the moves you can consider if they make sense for your risk tolerance and fit into your investment goals.
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Don’t go all in
It might be tempting to pour all your cash into the market when it is down, but this could be a foolish mistake. First, the market looks cheap to you based on where it was. If a stock was trading at $200 per share and now is trading at $75, is it cheap?
Based solely on the price, the answer is yes. But you can’t purchase investments this way. You have to look at the business and the economy as well. The stock could have traded as high as it did simply due to a one-time event or investors being irrational.
Take Peloton, for example. When gyms were closed, the best option for exercising at home was the experience that Peloton provided. As a result, sales were abnormally high, and so was the stock price. But now that gyms are open again and people have more options for working out, Peloton sales are down. The stock, which once traded at over $160 per share, is now trading for less than $10.
Is it a buy? Based purely on stock price, it looks like a bargain. But what are the odds it will trade at $160 again?
The same is true with the market as a whole. While a pullback from all-time high looks like a buying opportunity, with the risk of a recession on the horizon, there are much greater odds of the market going down than of it moving back up to and surpassing its all-time highs, at least in the near term.
At the end of the day, you don’t want to make the mistake of thinking a down market is temporary when it could be this way for a longer-than-expected period.
Don’t try to time the market
If going all in isn’t smart, you might think that waiting until the market drops a certain percentage makes good investing sense. The problem here is no one knows where the bottom is. A few people might get lucky and invest at the absolute bottom, but most people won’t. It is like playing the lottery. A few people win, but most others lose.
Look back to the market during the start of the pandemic. The S&P 500 Index closed at 3,380.16 on Feb. 14, 2020. One month later on March 13, 2020, it was down to 2,711.02, a 20% decline.
Most people probably thought that was as bad as it would get. But the market didn’t bottom out until March 20, closing at 2,304.92, a 32% drop. After falling this amount in roughly one month, where do you think the market would head next? Most people were scared at this point, assuming the market would continue to fall, considering it had just declined 10% in a week. But it did the exact opposite. It peaked on December 31, 2021, closing at 4,766.18 for a gain of 52% from the low on March 13, 2020.
Since no one knows when the market bottom is, the best option is to use a dollar-cost averaging strategy. To do this, invest a small amount of money over a set period to smooth out the market’s moves. For example, if you have $10,000, you can invest $2,500 each month for four months, or you could invest $1,000 a month for 10 months.
Dollar-cost averaging decreases risk by purchasing fewer shares when prices are high and more when prices are low. Note that this is a great strategy in a weak market, but not so great in a bull market environment.
Diversify your investments
Another critical tip to recession-proof your investments is to use diversification. This means you buy stocks in different industries and you may even want to consider adding bonds into your allocation. The more diverse you are, the less risk you assume.
The biggest mistake people make when it comes to diversifying is thinking that buying stock in two companies in the same industry is a form of diversification. It isn’t. Yes, you are spreading risk from one stock to two, but if the industry turns bad, odds are both stocks will drop in value.
A great way to look at this is to pretend you are an artist and want to create a picture. Diversification means you have access to crayons, markers, colored pencils, paint, charcoal, and more. You have many options should one of these mediums not be ideal. This is what investing in stocks in different industries is like. If you only have a red crayon and a blue crayon, you have different colors. But if you don’t want to use crayons, you will have difficulty creating the picture.
We all want to get a good deal and now might seem like a great time to take some chances on some stocks. But a negative market is not the time to speculate. The odds are great that bad news can come out and sink the market.
While bad news can come at any time, consider this phenomenon. When things are going great in your life, and you get some bad news, most times you can handle it and it doesn’t have a significant impact on your life. But if you are struggling and you get bad news, the news has a more substantial impact. It’s all about your mindset.
This is the same as the market. When the economy is strong and bad news comes unexpectedly, the market reacts and often shrugs it off. But when the economy is weak and bad news comes out, the market embraces it and drops.
If you are speculating during this time, you can quickly lose a lot of money. You are better served picking high-quality investments and waiting to speculate until things improve.
Invest in dividend-paying stocks
Speaking of investing in quality, dividend stocks should be at the top of your list. These stocks have strong balance sheets and a long history of stable income streams. When the market drops, these stocks tend to fare better. Not only is there a greater likelihood these companies will survive, but you are boosting your returns by getting paid a dividend even while share prices are down.
The best place to begin researching dividend-paying companies is to look at the Dividend Aristocrats List. This list comprises companies that have consistently paid and increased their dividends for 25 consecutive years. If you don’t want to invest in individual stocks, there are mutual funds and exchange-traded funds that invest in high-quality, dividend-paying companies.
Take advantage of options
Options, specifically call options, allow you to earn a little income on the stock you currently own. A call option works by you offering your shares of stock to another investor for a set price at a set time. The buyer pays you a small fee or premium in exchange for this option. If the stock is not trading at or above the agreed-upon price on the date specified, you keep your shares and the premium. If the stock trades at or above the set price on the agreed-upon date, you sell your shares to the buyer at the agreed-upon price.
There is little risk to you since you own the shares. The only risk you face is if the stock gains much more in value than you think it will by the time the option expires.
Consider actively managed funds
While many experts recommend the best option for retail investors is to invest passively through an index, now could be a smart time to consider actively managed funds. This is because there is a greater likelihood these funds will outperform the stock market.
When the market continues to move higher, it is difficult for managers to find undervalued stocks to invest in that will result in a higher return than the market. But when the market is dropping, it becomes much easier. The market return will be low, so even picking a few stocks that perform well can produce a better overall return. Granted, the fees for investing in these investments are higher, but the larger gains can offset this price difference compared to the market.
The bottom line
You can do nothing as an investor to avoid losing money when you invest in the market. But this shouldn’t stop you from investing, even during a recession. If you put in some work and invest strategically, you can preserve and grow your wealth, no matter the market conditions. Plus, Q.ai is here to help with AI-powered Investment Kits that do the legwork for you.
Download Q.ai today for access to AI-powered investment strategies.