The S&P 500 has undergone the worst start to a year since 2009. Oil has plummeted, China’s economy is slowing down, and global indexes are posting losses. The overall outlook is mixed. Some analysts believe the downturn is nothing unusual. Others say we’re approaching another global crisis like that of the dot-com bubble. Ultimately, market downturns and bubbles are impossible to predict. But for the savvy investor, a downturn is nothing to fear. A bear market offers an opportunity for those who are prepared.
If you’re convinced the market is heading for a crash
One method to weather a downturn is called dollar cost averaging. Dollar cost averaging (DCA) is a great method for conservative investors who don’t believe they can time the market bottom. The process is simple: buy a fixed-value amount of stock at regular intervals. Let’s say you have $1000 to invest. Instead of buying $1000-worth of an index fund at once, DCA would have you invest $100 per month over the course of ten months. If the market trends downward, your $100 gains more and more buying power each month. At the end of the 10-month period, your total number of shares is higher than if you’d bought $1000-worth outright. Thus, your returns when the market rises are much greater than someone who invested all at once.
A recent analysis showed that an investor using DCA to buy an index fund every month throughout the 2008 recession would have earned a 41.3% return from October 2007 to December of 2015. This example assumes the investor started DCA at the absolute wrong time — October 2007, the market peak before the crash. Yet they still rode the plunge and rise to make a tidy return of 4.3% per year. Why? Because DCA is not about timing the market. It’s about buying the trend slowly and steadily over time.
If you want to make your investments “recession-proof”
Diversify your assets. Spreading your money between stocks, bonds, international funds, real estate, and even cryptocurrencies will limit your exposure to toxic areas of the market. You could also buy into “counter-cyclical stocks” or “foul weather funds” that perform well during a recession. These stocks represent a business that profits during economic downturns. However, the safer, hands-off bet is to buy Blue Chip companies with stable revenue, large cash balances, and a long history of paying dividends. They are most likely to survive an extended recession. But remember: past performance is no indication of future results.
Bond funds offer another way to protect your exposure to a deflationary market. The returns are much lower than the market but any positive growth is better than a loss. U.S. Treasury Bonds — the most stable and secure of all bonds — are the most popular debt instrument in the world, but you can also buy municipal bonds and corporate bonds, or a bond market ETF that offers a mix. Municipal and corporate bonds offer higher returns than Treasury bonds, or T-bonds, but also higher risks. Currently, foreign investors have moved large amounts of capital into Treasury Bonds due to the weak global economy and poor outlook. As a result, bond prices have gone up and yields have gone lower — meaning it costs more to own a bond and the percent-return is low. However, they are still a secure way to protect your funds from a falling market. Bonds offer another advantage. Because of their global popularity, bonds are easy to sell and extremely liquid. Thus, the savvy investor can stash money in bonds as the market falls then sell the bond for a small profit and move funds back into a more aggressive stock portfolio. But this requires timing the market to some degree, which no one can do without a great deal of luck.
During the 2008 crash, bond funds sustained moderate growth while the market was in a tailspin as capital flowed out of stocks and into bonds. If you’re already invested in bonds, you will enjoy the brunt of these gains and offset your losses in other sectors of the market. Diversification is key.
If you want to maximize your security and make money
Make sure you have a healthy cash savings. Most experts agree you should have between six months and one year’s worth of expenses in a rainy day fund. This money will pay for unexpected crises, such as medical bills or auto repairs, and provides security for you and your family if you lose your job unexpectedly — which is a difficult event that many face in turbulent economic times. A large rainy day fund makes this worst case scenario far less stressful.
Large cash savings have a valuable secondary purpose. The money can also buy shares of your favorite companies during a market trough. This strategy is called value investing. Who wants to pay full price for stock when you can buy shares at a discount? Warren Buffet famously said, “Be fearful when others are greedy, and be greedy when others are fearful.” A recession is the best time to exercise this philosophy. You can buy strong companies that are temporarily depreciated due to a poor economic climate and enjoy hand over fist gains when the market rallies. This is a winning investment strategy that anyone can employee successfully. You need not buy companies, sectors of the market, or ETFs at the absolute market bottom; you need only to buy them when they are undervalued. If your preferred stocks have depreciated in value along with the market, it is a reasonably safe bet that they will recover with the market. However, make no mistake, this is still a bet. Conservative investors will take Buffet’s advice and invest in Blue Chip companies with years of stable earnings. But remember: you can only take advantage if you have money in the bank.
Start saving now. If you believe the economy is heading south, you should cut spending for the sake of spending. The bear market is a money maker for those with cash on hand. Every dollar that comes through your bank account should go to its best use. And that goes doubly when the economic outlook is unclear.
David is a writer for MyBankTracker. He is an expert in consumer spending and financial literacy.