Recessions and Their Impact on Investing

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What happens to the stock market during recessions? And how can you prepare?

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The answer might not be what you expect.

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One important thing to note from the start is that the stock market is not an accurate reflection of economic strength.

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• Recessions occur when economic growth slows.
• They're often painful, scary, and take months or years to sort themselves out.
• Recessions are common, and often helpful in creating efficiency and rebalancing the overall economy.
• While stock market activity can show how people are perceiving the economic situation (for example, flighting to gold or bonds during times of business volatility), not all stock market moves are exemplary of underlying, current economic conditions.

With that, let’s jump in…

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How does this affect you?

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During recessions, headlines appear scary, and people are often more tense. Layoffs become daily occurrences, consumers spend less, and it feels like a lot of doom and gloom. It stinks to see retirement accounts drop in value.

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However, the stock market is *forward looking*. This means that stock markets typically drop, and then they rebound *before* the recession is actually over.

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Take a look at this graph:

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The recessions are labeled with the grey vertical lines, and the blue line represents the S&P 500 (a collection of the top 500 U.S. companies). 

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The red Xs indicate when the markets reached the bottom.

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Notice how in most cases, the stock markets bottomed and then made strong recoveries even while the economy was still in a recession.

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How do you prepare?

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First of all, don’t overreact.

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While no one can predict the future, it's much easier to stomach a large value reduction in investment accounts when you know that they will eventually recover, even while the sky feels like it's falling around us. 

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Trying to time the markets is a tricky proposition. For many people, by the time they decide to sell, the market has already fallen significantly. If they don't re-enter their investments, they miss out on the value gains on the market's way back up.

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Most people don't buy because they're afraid the market will continue going lower. It could. You could purchase something and it immediately drops further. This feels bad. But it's not a good reason to not invest. No one can predict when the markets will reach the low point.

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Then, they become bitter towards investing, are nervous to invest, and struggle to make meaningful progress toward retirement savings.

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This, more than anything, is the cycle that I hope to help you prevent. 

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This is also the reason that even famed investors like Warren Buffet advise the simple approach of betting on the broad market over time. It will come back and grow. You can see this in the dramatic rise in index funds and the success of low fee providers in recent decades.

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The Delta:

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• Historically, markets have always recovered and reached new highs after recessions.
• Emergency savings help reduce short-term uncertainty/anxiety (3-9 months of expenses is a good rule of thumb).
• The stock market recovers faster than the overall economy.
• Headlines will look scary. It's best to avoid doom scrolling.
• Zoom out. It's easy to get sucked in to how much the market drops in a 1 month, 3 month, or 6 month time period. If we switch our thinking and consider that we're investing over 10-30 years, it puts these short term drops in perspective.

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Lastly, if we can take the emotion out of investing, recessionary periods are some of the best times to invest. It's like the companies are on sale!

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