To many investors, December 2007 felt like a nightmare scenario: the United States was officially in a recession. What would tomorrow bring? How much would we lose? As it continued, we worried: would we see another Great Depression before we ever saw more economic growth?
People panicked and made bad decisions that permanently affected their net worth.
Very few things drive emotions greater than love and money—especially if you’re approaching retirement when there is heightened fear of a recession, your 401(k) has a few bruises from a volatile market, and the interest rate continues to rise. If there is one thing the Great Recession exposed, it is how vulnerable our long-term plans for retirement or college savings become when markets and economies start to recede.
But how did our plans become so vulnerable in the first place?
2 common fatal mistakes to avoidAfter managing money after the Dot-Com Bust and The Great Recession, I can tell you that recessions and bear markets can cause even the most sensible of individuals to fall victim to their emotions and make some fatal investing and savings mistakes. It’s understandable, considering a significant decline in economic activity can lead to a financial crisis. Unemployment rates can go way up. The news runs constant stories about housing markets and oil prices.
It’s only natural that people panic. But with that panic comes fatal investing mistakes.
Most fatal mistakes I’ve observed fall into two categories:
These two habits usually intertwine, since one tends to lead to the other.
The simplified version of this process looks like this:
Step one: The stock markets perform well just before a recession, so investors buy at prices too high (taking on too much risk).
Step two: During the recession, the value of those investments drops further than expected, so investors sell at prices too low (losing sight of goals/panic selling)
When you do your homework, you will find that almost every recession has been preceded by a time of out-of-ordinary expansion, growth, and investor euphoria, just like we saw in 2021. During these times, many investors chase the dream and invest too aggressively.
Even worse, they can become complacent and stop monitoring their investments. It is usually these investors that then make the fatal mistake of selling those investments when the recession is near its end and the financial markets may be at their lowest prices and ready for recovery. Eventually, everyone has a point of capitulation when they see their money evaporating. Many times, this causes an investor to sell when they should be buying.
Time buckets: a recession investment strategyWhat are the best ways to avoid this fatal error? In my experience, I’ve found that the best way to invest during economic downturns is to:
When used correctly, I’ve seen this strategy turn the economic death knell of a recession into an investment opportunity.
Time buckets might differ depending on your individual goals, but I like to divide them into three time horizons:
Short-term bucketsI like to create a one-time bucket for short-term surprises or opportunities. These are funds that remain mostly liquid and accessible. This way, you have funds available to you should you find a quick or short-lived investment opportunity.
These opportunities aren’t usually for long-term investments. These are usually quick trades intended to pay off in a short amount of time. Having short-term pay buckets also helps you have accessible funds should you suddenly need to make a more personal purchase.
Intermediate bucketsIt’s also a good idea to have an investment bucket that exists in a more intermediate time frame. These are investment funds you might not access for 2-5 years. This gives you a little extra luxury time for investments that might have more day-to-day volatility but could trend upward over time.
The recession might push down the price of some of these investments—but that could create more opportunities. Because you don’t need to access that money now, you can hold those investments until they begin to trend up. This also gives you the chance to invest more in good quality companies at lower prices that you can hold until prices rise.
Long-term bucketsAnd last, it’s helpful to have a long-term bucket that is focused on your long-term goals, like retirement or health care expenses. With this longer-term bucket, depending on your age, you can be strategic with your risk and cash management by building cash and reducing risk in times of market euphoria that precedes the recession. This can help you have “dry powder” to be able to turn a recession into an opportunity to buy more quality assets at lower prices.
The bottom lineSometimes, losses are unavoidable. When those times happen, it is important to remain calm and place your focus on the quickest path to recovery instead of worrying about what you’ve lost.
If an investor wants to avoid the most popular and fatal recession investing mistakes, they should follow the famous line from Sir John Templeton: “When everyone else is greedy, you should be fearful. And, when everyone else is fearful, you should be greedy.”
What effect could #crypto and #blockchain have on this recession? Dont forget about #AI and #Chatgpt give investors advice.
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