Remember the good ol’ days of unlimited gains and instantaneous profits?
Well, those days are likely over.
In this new economic environment with greater volatility, tighter margins, and expensive debt, many investors are heading into unfamiliar territory, where unprofitable businesses bust and speculative stocks sink to all-time lows.
Though it’s sad to see the good times come to an end, the reality is that recessions happen, and they happen more often than you might think.
Therefore, rather than sitting on the sidelines and moaning about your losses, why not jump into action and take advantage of one of the most lucrative investment opportunities of our lifetime?
Fortunately, it isn’t as difficult to invest in a recession as some make it out to be.
In fact, investing during a recession can often be the best time to buy stocks because there are more opportunities to find excellent businesses trading at a discount.
As Warren Buffet once said, “greedy when others are fearful” and this recession is no exception.
In this article, we explain how to find recession-proof stocks, why investing during a recession is advantageous, and how to invest in growth stocks during a recession.
If you are a serious investor wanting to improve your financial standing, you do not want to miss out on the opportunities that this recession could have in store for you.
What is a Recession?
Recessions are rough.
According to the National Bureau of Economic Research (NBER), a recession is defined as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
Though each one is different, recessions always involve a decline in production and employment, which results in households and businesses spending less of their income in the period.
This in turn drives the recession even deeper, creating a negative feedback loop as investors anticipate a market downturn and worry about greater economic uncertainty.
To determine a recession, most economists argue that two consecutive quarters of declining gross domestic product makes sense, however, this indicator has been heavily scrutinized in recent times due to its inability to measure the economy more broadly.
Instead, the NBER prefers to use a more diverse set of criteria that includes metrics like real personal income, nonfarm payroll employment, real personal consumption expenditures, wholesale-retail sales, and industrial production.
Since there are more factors at play, it can sometimes be difficult to determine exactly when a recession is occurring, therefore it’s easiest to zoom out and try to gauge the entire situation.
But no matter what criteria you choose to use, in essence, a recession happens during the contractionary period of the economic cycle where you begin seeing productivity, employment, spending, and investing decline.
What Causes a Recession?
There are many reasons why a recession might happen.
Although investors try to point to one particular cause, the reality is that recessions are more like an economic domino effect, whereby multiple events lead to the disruption of growth in an economy.
Usually, after periods of accelerated inflation and rising asset values, a central bank like the US Federal Reserve will attempt to stabilize economic growth by introducing interest rate hikes.
This in turn discourages investing and borrowing as debt becomes more expensive which leads to businesses and households choosing to hold onto more of their cash in the event of a credit crunch.
As the economic conditions worsen, the economy eventually reaches a tipping point whereby the house of cards finally collapses and the economic firestorm begins.
Some examples of recession catalysts from the past are asset classes bursting (ex. real estate in the Great Recession), a complete shutdown of the global economy, including supply chain disruptions (ex. Global pandemic in 2020), and rampant inflation like what we are experiencing today.
However, no matter the reason for a bear market, it is important to understand that they are a natural progression of every economic cycle and happen a lot more often than you might think (16 recessions over the past 100 years).
As such, since these economic slumps are inevitable, the best thing to do is to learn how to invest during a crisis so that you can take full advantage of the highly volatile markets headed your way.
For more on investing in a recession, check out our article here.
How to Invest in Growth Stocks During a Recession
Investing during a bear market can be intimidating for a multitude of reasons.
With inflation high, mortgage rates soaring, layoffs happening left and right, a stock market crash, and more, it can be difficult finding the time or money to invest, especially when all hell breaks loose around you.
That being said, there is no better time to make it happen.
By whatever means possible, if you can put some capital aside, it may end up being the best decision you ever make.
Because as Warren Buffett once said, “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, reach for a bucket.”
So with that all covered, here’s how to do it.
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Cash Is King During a Recession
There is a common saying amongst investors that time in the market beats timing in the market.
While true, it is also valuable to have some cash on hand, just in case something unexpected happens.
By building an emergency fund that covers at least 3-6 months of your household expenses, you can be sure that all your basis are covered for the time being and that you never put yourself in a position where you end up selling your hard-earned assets if the recession hits.
Even better, if you can set aside an extra cash reserve within your investment portfolio, this can be extremely advantageous for when the downturn and subsequent stock market crash arrives because it will allow you to swoop in and snatch up high-quality growth stocks at a discount.
Heck, even Warren Buffett and his company Berkshire Hathaway are sitting on $147 billion in cash.
While it is always better to be invested than to have no investments at all, by having liquid cash at your disposal, you set yourself up to take advantage of any opportunities that arrive during the recession.
Even if it is just some spare change hanging around, it still gives you the chance to buy a few shares.
Remember, cash is king during a recession
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Buy Quality Assets During a Recession
As a general rule of thumb, investing in quality assets is a good idea no matter the economic environment.
However, this is even more important during a recession because many unprofitable growth stocks will be destroyed during economic downturns.
So what makes a quality asset, or stock in this instance?
Buy Money-Making Growth Stocks
Well, to begin, you want to invest in businesses whose products and services are still being used despite the slump.
To determine this, look at the company’s past performance through its financial statements and annual reports.
By knowing that your stocks are making money organically, you limit your risk by avoiding situations where a business is cash-strapped and dependent on financing, which ultimately collapses if it cannot find funding.
Not only that, but by having recurring cash at its disposal, a business can continue growing without disruptions, which allows it to strengthen its competitive position in the market, while other businesses struggle to survive, even if the stock price falls.
This means that for the time being, it’s best to focus solely on growth stocks with strong earnings growth, and not just revenue growers because you want to be sure that they are capable of overcoming an economic downturn.
Far too often, businesses appear healthy on the surface because they are growing revenues hand over fist, but in reality, they are fledgling companies barely staying alive.
Sure, when the market is expanding and capital is easily available, it makes sense to invest a little more in these high-growth companies, but when the times are tough and funding gets tight, the last thing you want to be doing is buying a stock that could cave in tomorrow.
As a general baseline, the more profitable years of operation a growth stock has under its belt, the better.
Avoid The Debt Trap
“Debt is like any other trap, easy enough to get into, but hard enough to get out of.” – Henry Wheeler Shaw
In the good times, debt can be a great tool to help accelerate growth and accomplish your dreams.
However, in the bad times, debt can be a disaster that wipes away everything and leaves you with nothing.
The same goes for businesses.
Therefore during a recession, it is best to avoid stocks with high debt loads altogether because these stocks tend to be the most vulnerable to changing credit conditions and the first to fall during a downturn.
That being said, since most companies use debt to some extent, a good measure of whether or not to invest in them is if they can pay off their loans in less than three years.
To calculate this, simply divide a company’s total debt by its free cash flow.
If this number falls below three, then that means the business can pay off its debt in less than three years which is an indication that they are in solid financial standing.
For example, Company A has $1 billion in debt on its balance sheet and made $375 million in free cash flow last year, while Company B has $50 billion in debt and made $5 billion in free cash flow.
If we divide each company’s debt by its free cash flow, we will find that Company A has a payoff period of 2.67 years, whereas Company B has a payoff period of 10 years.
In this instance, we would prefer Business A over Business B because it requires fewer years to pay off its debt, meaning that it is less susceptible to rising interest rates and bankruptcy, and can also retain more of its cash over the long run.
During an economic downturn, the key is to limit risk as much as possible by focusing on recession-resistant stocks that have strong balance sheets and disciplined managers.
In doing so, you will spare yourself any bad news as your high-value stocks continue growing into the future.
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Don’t Overreact During a Recession
Last, but certainly not least, do not overreact during a recession.
With so much fear, uncertainty, and doubt (FUD) in the markets, it can be easy to let your emotions get the best of you.
Especially when stock prices tend to fall during a bear market, the goal is to hold strong throughout the downturn so that you can reap the rewards of the bull market that follows.
If anything, you want to be buying more of the stocks that you own because they are now trading at a lot cheaper price, meaning that you can increase your ownership stake for less.
To help you with controlling your emotions, make sure that you follow the first two steps to investing during a recession that we mentioned earlier.
By focusing on good investments like high-quality growth stocks, you can be confident that your capital is in good hands regardless of how the stock performs in the short run.
And even if the stock price falls lower than you expected, by having some cash on hand, you avoid needing to sell your stock if living expenses get in the way.
Managing one’s emotions is one of the most difficult challenges of being an investor.
But if you can remove them from your investment strategy by focusing on the long-term game, then you are already one step closer than most when it comes to financial freedom.
Are Growth Stocks High Risk During a Recession?
Like with any investment, there is always some risk involved.
In this case, growth stocks can be at high risk if such companies are unprofitable, over-leveraged, or fail to create real value in society.
Therefore, the best way to avoid risky stocks is to buy high-quality businesses, as we mentioned before, and to purchase them at discount to their intrinsic value.
That way you not only protect your downside but also capitalize on their exceptional growth when the market turns around and the economy finally recovers.
Ultimately, our goal as investors is to achieve financial freedom in the smoothest way possible.
While some investors may believe that this is best achieved through defensive stocks like consumer staples, cyclical stocks, or dividend stocks, we would argue that some growth stocks deserve to be on this list as well.
But no matter your investing strategy, the key is to ignore investor sentiment and to focus on finding individual stocks that are capable of enduring the next recession.
That way you can be sure your money is compounding for the long run.
To learn more about our growth investing strategy, check out our beginner’s guide here.
Final Thoughts
Investing during a recession can be intimidating due to the greater uncertainty taking place in the economy.
However, it can also be one of the best opportunities for investors to take advantage of cheap assets that are otherwise overpriced or un-investable.
As such, now is the perfect time to start preparing for a recession so that you can make the most of the next downtrodden market.
Whether it happens three months from now, or in the next three years, it is always wise to build a growth portfolio that avoids unnecessary risk and limits your emotional biases.
By investing in a collection of wonderful undervalued businesses you will achieve just that.
With the likelihood of a recession occurring increasing every day, why not make the most of this fantastic opportunity?