Investing during a recession may seem counter-intuitive especially as here in the UK, it’s recently been announced we are heading into a pretty severe recession on the back of COVID-19 and all of the financial implications of the virus.
This will naturally leave many investors worrying about their investments and wondering ‘should I keep investing in the stock market during this period of financial turbulence?’
As far as an individual’s financial situation will allow it, investing during a recession is a good idea. Not only does this maintain the cornerstone habit of consistently investing, but it may also present an opportunity to buy company shares at a cheaper price than you may otherwise be able to.
For many, a financial recession will create major issues such as unemployment concerns and financial distress but for those who are able to maintain their typical income throughout the recession period, there is a lot of sense in remaining consistent with your established investing habits in order to build wealth over the long-term and ultimately become financially independent.
Why investors should keep investing during a recession
Let’s first address the elephant in the room – if a financial recession leads to unemployment or poverty for an individual, clearly investing isn’t going to be the priority for that person. Whilst fair critiques of a system that allows people to fall into poverty, homelessness and other injustices during a recession could be made, that’s not the purpose of this website.
This website aims to help improve readers financial literacy and talk through the steps towards becoming financially independent which is my ultimate goal.
Given our current context of a COVID-induced recession here in the UK and presumably in many other parts of the world as well, let’s talk about investing during a recession for those whose financial situations currently allow it.
As you will see throughout the post, my stance is that it makes financial sense to carry on investing despite the recession and this habit will help prevent anxieties around market fluctuations which trip many individual investors up.
Investing should be a consistent monthly exercise
As I wrote about recently in a piece on ‘How to use compound interest to your advantage‘, building long-term wealth through low-cost, passive index funds is heavily reliant on consistent investing, especially during your younger years.
I’ve found the easiest way to stick to this is to automate it. Within my investing platform, I simply set-up a monthly investment instruction to my fund of choice and set-up a direct debit from my bank account to fund this investment.
That way, your investing is taken care of by default and you are “paying yourself first” and are allowing compounding to do it’s thing and gradually increase your wealth.
If we were to stop investing during a recession despite having the financial means to do so, we would break this habit, reduce our invested amount and limit our future growth.
Why selling investments during a recession is a bad idea
Whilst my stance on this issue is that I will continue to invest during a recession, I can at least understand why some people would choose not too. What I can’t understand, however, is those who decide a recession is the right time to sell their investments.
When it comes to buying and selling company shares, either directly or through funds, the valuation of these investments will fluctuate over time as the share prices of the underlying companies change. For instance, your investment portfolio may be worth £10,000 one day and just £8,000 the next.
What’s important here though is that on the day where it’s worth £8,000, you have only made what I refer to as an ‘unrealised loss‘. What I mean by this is that that same portfolio could be worth £11,000 the day after so this is only really a ‘loss’ if the investments are sold at this low value.
This is essentially what’s happening when investments are sold during a recession. Basic economics tells us that stock markets tend to go down during financial recessions as consumers have less disposable income, so businesses make fewer sales and therefore have less revenue and therefore the stock valuation decreases.
This is of course over-simplified and the mechanics of stock market prices are much more technical than this in reality but for the purposes of this article, the assumption that stocks tend to decrease during a recession is a fair one.
If you sell during a recession, it follows that you are likely selling your investments at a point in time when the stock market is down i.e. the underlying company shares are worth less than they previously have been.
Selling at this point is, therefore, the single worst thing investors can do as they would be locking in a loss. If the recessionary period is ridden out, the value of the investments is likely to return to much more normal level over time and this loss can be avoided altogether.
Changing your investment strategy during a recession is a fear-based approach
This brings me on nicely to my next point; changes to your investment strategy during a recession is almost certainly a fear-based response.
The fallible human brain will see the value of your investments plummeting during a recession, panic and start screaming something along the lines of ‘sell them now before they go down even further!’
On the face of it, this makes some sense – it’s better to get something than nothing. The problem is this thinking completely ignores the realities of the stock market and plays into the common human fear known as ‘loss aversion’.
In ‘Thinking Fast and Slow’, Daniel Kahneman explains this ‘loss aversion’ concept as the belief that the pain associated with losing is twice as emotionally powerful as the positive impacts of gaining. When investors see their portfolio value tanking, this inbuilt aversion to loss kicks in and they are driven to sell.
The superior response would be to notice your investments declining and automatically tell yourself “stock prices fluctuate over time, as long as I don’t sell now I won’t lock in this loss and in time my investments will be back up in a gain position based on the historical returns of the stock market”.
Let logic, consistency and a well thought through plan drive your investment decisions, not fear, greed and other emotions us humans are susceptible too.
Investing during a recession let’s you buy stocks that are on sale
For experienced investors, a recession and the ‘bear market’ that often follows represent a big opportunity.
The stock market is split into periods of ‘bull markets’ (where the stock market is going up) and ‘bear markets’ (where the stock market is going down). To remember these terms, I think of the bull statue outside of the New York Stock Exchange and think why would they put a bull outside if that wasn’t a good thing (i.e. stock market going up).
When the stock market is down, this is almost certainly because many of the stock market constituents (i.e. the individual companies with publicly traded shares) have seen their share price decline.
For investors, it may be initially concerning to see our portfolio values decline but it should also tell us that this is a great time to invest.
Let’s say you came across a painting worth £1,000. You are pretty confident in 40 years time the painting will be worth much more and so you buy the painting for £1,000. A year later, you get the painting valued and are dismayed to find it’s now only worth £500.
You have two options here.
A) the bad option, cut your losses and sell the painting now and lock in a £500 loss. or
B) the good option, hold onto the painting and trust that the painting will be worth much more in 40 years time as you initially thought.
What if I told you there was a third option? Another copy of the painting has become available and because it is currently only valued at £500, you have the option to buy it for that price. I.e. half the price of the previous painting you bought.
As long as you still believe these paintings will be worth much more in the long-term, the logical thing to do here is snap up the second painting at a steep discount.
Hopefully, the metaphor for the stock market is clear here. The second, cheap painting at just £500 represents company shares you can buy during a recession. Regardless of the recession, you believe these shares will be worth far more in 40 years time – so why not buy more now at a cheaper price?
Get into the habit of prioritising investing over consumerist spending
The final reason to carry on investing despite a recession is to maintain the habit. As soon as you stop investing for a month, it becomes easy to stop for two months, three months or longer.
Assuming your career and income isn’t too badly affected, this will result in more money being saved and likely spent on products and services which are far less valuable than investing.
When investing a set proportion of your income is foregone, this same chunk of money tends to go on superfluous purchases which bring little value other than small dopamine hits in the form of instant gratification.
Whilst investing money wisely won’t provided this same instant gratification, the benefits such as long term wealth and financial freedom will be worth far more in the long-run.
What about if I can’t afford the essential costs of living during a recession?
Maslow’s hierarchy of human needs tells us that our needs come in five tiers;
- Physiological (air, water, food, shelter)
- Safety (security, employment, resources)
- Belonging (relationships, friendships)
- Esteem (status, freedom, recognition)
- Self-actualisation (becoming your best self).
Investing consistently falls into the fourth tier via building your financial freedom and setting you on your way to achieving the fifth tier; self-actualisation.
If a financial recession strikes an investor especially hard and they were to lose their job, clearly the priority in this case would be the essentials needed for living and the main concerns for the individual at that point would be tiers one and two of the above hierarchy.
If I had existing investments and were to be hit by difficulties such as these, whilst it may be unavoidable, I would do everything possible to avoid selling my investments and locking in a loss even if that meant dramatically cutting my monthly living expenses and way of life.
Conclusion
Financial recessions can have life and death level consequences for significant parts of the population but for those fortunate enough to maintain their pre-recession income, halting your investing during this period of financial upheaval doesn’t make a whole lot of sense.
A cornerstone habit of building long-term wealth is the consistent, relentless habit of investing a proportion of your income each month. If this habit is disrupted through fear and an overly-cautious stance of hoarding cash during a recession is adopted, this may cost you significant investment growth in the long-term.
Whilst it may sound morally objectionable to say given the hardships many face during a recession, this period may actually represent an opportunity for investors to buy company shares ‘on sale’ at share prices significantly lower than the typical level.
Buying shares at a low price will inevitably lead to higher returns as the share prices return to a normal level as the recession passes.
Whether individual investors are able to take advantage of these low share prices is completely dependent on the individual’s financial situations and level of disposable income but if you find yourself with money left over at the end of the month, a recession is a poor reason to not invest it as you ordinarily would.
As always, please remember I am an Accountant, but not your Accountant. In this post (and all of my others) I share information and oftentimes give anecdotes about what has worked well for me. However, I do not know your personal financial situation and so do not offer individual financial advice. If you are unsure of a particular financial subject, please hire a qualified financial advisor to guide you.
This article has been written by Luke Girling, ACA – a qualified Accountant and personal finance enthusiast in the UK. Please visit my ‘About‘ page for more information. To verify my ACA credentials – please search for my name at the ICAEW member finder. To get in touch with questions or ideas for future posts, please comment below or contact me here.