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If a recession might be coming, is now a good time to invest?

I know the title sounds a bit clickbaity, but it's a question that clients have been asking, so I figure it's worth answering!

Having said that, there are a few aspects of that question I want to explore, and then I'll let you figure determine the answer for yourself. As you might guess, it's not as simple as "yes" or "no", and as Westley says in The Princess Bride, anyone who says differently is selling something!

First: a recession is always coming.

(I feel like Ned Stark when I say that!)

While the various governments of the world do indeed have levers to pull to try and discourage this, there's only so much they can do, even if they pull every lever at exactly the right time (which doesn't always happen, as we saw with the Fed's belated response to inflation last year). Downturns will happen. Another Great Depression, or oil embargo, or savings and loan crisis, or tech bubble, or subprime mortgage crisis, or global pandemic, or post-pandemic inflationary crisis, or something else will happen. It's just a matter of when.

Lock that into your mind: a recession is always coming, and we don't know when the next one will be. Build your financial plans, including your portfolio, around this fact. Don't overextend and open yourself up to vulnerability. What does that mean? Well, that's between you and your IPS, but it might look like the following:

  • Don't speculate with money you can't afford to lose permanently. (Enron went to zero and never came back.)

  • Don't miss out on easy wins like paying off high-interest credit card debt.

  • Don't skimp on your primary emergency fund.

  • Don't take risks with your primary emergency fund.

If you build this into your mindset, then when the next recession hits, you'll already be prepared, long before anyone else sees it coming!

Recessions don't break (well-constructed) portfolios.

In other words: a recession is always coming...but that's okay. (Or at least it can be, if you're prepared. See above!)

I mentioned this in an article a few weeks ago, but it's worth bringing up again (and again! and again!): the return on a well-diversified, 60% stock portfolio from 10/1/2007-10/1/2012 was 4% annualized, after a 26% drop from 10/1/2007 to 3/1/2009.

Chew on that for a bit -- the worst recession since the Great Depression, and five years later it was (as far as your portfolio was concerned) a minor speedbump. 4% isn't a great rate of return, but it's a whole lot better than what you would have gotten from cash!

Of course, if your portfolio wasn't well-constructed, you might have lost quite a lot more than half your equity allocation, and if it didn't match your risk tolerance and capacity, then even a temporary near-30% drop might have been a serious blow to your financial plan.

But assuming you're doing financial planning The Seaborn Way, 2008 was just a moderate course correction. Not much changed, certainly not for the long term.

If it's ever a good time to invest, it's always a good time to invest.

That's the beauty of efficient markets. Now, we can argue until we're blue in the face as to whether the publicly-traded stock and bond markets are "perfectly efficient", which would involve discussion of the weak, strong, and semi-strong efficient market hypotheses and even what the term "hypothesis" connotes in a statistical, rather than scientific, context.

That's not really relevant, though, as fun as it is to dive into. The markets are efficient enough such that you can expect stocks to beat bonds, both stocks and bonds to beat cash, etc. Does it always happen? No -- which is, if you think about it, why there's such a thing as a risk equity premium in the first place. Stocks earn more than bonds precisely because investors demand an increased return for their (short-term) risk; otherwise, they'd just invest in bonds!

So: given that markets are at least highly, if not perfectly, efficient, public securities are constantly -- every second of every trading day -- being repriced such as to make them a "good deal" relative to their risk. And thus, assuming you're not overextending (see above!), it's a good time to invest.

By the time you think a recession is probable, it's already priced into the market.

Because of their efficiency, markets respond very quickly to news, or even the hint of coming news. By the time the Fed voted to raise rates in March of 2022, mortgage and other interest rates had already risen ~1% from their January positions, in anticipation of the move.

It works the same way for good news, too. When the pandemic came in 2020, the market crashed by around 30% from its February high to its March low...and was promptly back to its prior high by August, even though (for example) the unemployment rate, which was below 4% before March, didn't get back below 4% until September of 2021!

For you to consistently beat the market when it comes to recessions, you would have to see it coming before it even seems likely to happen. A material chance of recession is already priced into the 2022 market as I write this! Sure, you might get lucky and outguess the market, even with the odds stacked against you...but you might also get lucky playing slots in Vegas. Moreover, your odds of beating the house go down the longer you play, and investing means being in the game for decades. In that case, why not be the house instead?

So...what do I do?

I hope this post has provided a good mental framework for thinking about recessions...but actionable takeaways are good, too! Here are some things you might consider, depending on your situation:

  • Construct a well-diversified portfolio that matches your risk tolerance and risk capacity, and don't be tempted to mess with it during market fluctuations.

  • Always be hedging against recession -- even during bull markets -- primarily by keeping short-term and emergency savings in stable cash equivalents, like online savings.

  • If you don't need the cash in the short term, you can confidently invest it for the long term -- no matter what the market is doing.

And that's really what 90% of investing boils down to: controlling what you can (diversification, saving for short-term needs in cash), and ignoring what you can't (market fluctuations)!

Britton is an engineer-turned-financial-planner in Austin, Texas. As such, he shies away from suits and commissions, and instead tends towards blue jeans, data-driven analysis, and a fee-only approach to financial planning.


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