Why Savvy Investors See Opportunity in Volatility
If in doubt, check the data. The numbers don’t lie.
A stock market recession, or slowing economic growth can be one of the best times to be investing. Whether it’s increasing your regular monthly contributions, adding idle cash sitting in your bank account, or getting started with your investment portfolio, all can be a sensible strategy during these volatile times.
This week we’re exploring the data and why investors should be seeking to use this volatility as an opportunity, rather than anything to be afraid of. We’ll be taking a look at previous recessions, and outlining why successful investors see recessions as an opportunity to invest in growth assets.
A recession is a period of economic decline characterised by a decrease in gross domestic product (GDP), employment, and other economic indicators. Recessions are usually accompanied by a decline in the stock market, which can be unsettling for investors. However, the best investors see recessions as opportunities for growth rather than reasons to panic. In this blog post, we will explore why the best investors approach recessions this way, and the advantages and risks of investing during a recession.
A walk down memory lane
Many of the most successful investors in history have been able to thrive during recessions. Warren Buffett is one such example. During the 2008 financial crisis, when the stock market fell by over 50%, Buffett invested heavily in companies such as Bank of America and Goldman Sachs. He later called the crisis an "extraordinary period" and said that it provided a great opportunity to invest in the stock market.
Another example is John Paulson, who made billions of dollars by betting against the housing market during the 2008 financial crisis. Paulson saw the housing market was overinflated and likely to crash, so he took out credit default swaps on mortgage bonds, essentially betting that these bonds would fail. When the housing market did crash, Paulson's bet paid off, and he made billions of dollars.
Advantages of investing during a recession
Some of the key advantages of investing during a recession include
- Lower prices and valuations of stocks: During a recession, the stock market tends to decline, which means that stocks can become undervalued. This presents an opportunity for investors to purchase stocks at a lower price than they would be able to during a bull market.
- Potential for increased returns in the long run: Historically, the stock market has always recovered from recessions and gone on to reach new highs. This means that investors who are willing to hold onto their investments through the recession have the potential to earn significant returns when the market eventually rebounds.
- Possibility of acquiring undervalued assets: During a recession, some companies may be forced to sell off assets to raise capital, which can present an opportunity for investors to acquire undervalued assets. For example, if a company needs to raise money quickly, they may sell real estate, equipment, or other assets at a discount.
- Less competition from other investors: During a recession, many investors may sell off their investments in a panic, which can create less competition for those investors who are willing to hold onto their investments. This can make it easier to find undervalued investments and take advantage of buying opportunities.
The risks of investing during a recession
Naturally, investing in stock markets does not come without its risks, and we should be aware of these when making any financial decision. Some of the key risks include the following:
- The potential for continued economic decline: It's important to remember that a recession can continue for an extended period of time, and the economy may not immediately recover. This means that investors may need to be prepared to hold onto their investments for an extended period of time.
- Uncertainty and volatility in the markets: During a recession, the stock market can be highly volatile, which can be unsettling for investors. This volatility can make it difficult to make informed investment decisions.
- The risk of investing in a company that may not survive the recession: Some companies may not survive a recession and may go bankrupt. This means that investors who purchase stocks or assets from these companies may lose their entire investment.
How to invest during a recession
Some of the key strategies to adopt when it comes to investing during times of a recession include:
- Importance of diversification: Diversification is key when investing during a recession. Investors should spread their investments across different asset classes, such as stocks, bonds, and real estate, to reduce their risk.
- Focusing on companies with strong fundamentals: focus on companies with strong fundamentals. This means looking for companies with a healthy balance sheet, a solid management team, and a competitive advantage in their industry. These companies are more likely to survive a recession and come out stronger on the other side.
- Taking a long-term perspective: Investing during a recession requires a long-term perspective. It's important to remember that the stock market has historically always recovered from recessions and gone on to reach new highs. Investors who are willing to hold onto their investments through the recession have the potential to earn significant returns in the long run.
- Keeping a cash reserve for opportunities that may arise during the recession: During a recession, there may be opportunities to purchase undervalued assets or stocks at a discount. Having a cash reserve available can allow investors to take advantage of these opportunities when they arise.
What does the data tell us?
Empirical evidence supports the idea that recessions can present opportunities for growth for smart investors. A study by Fidelity Investments found that investors who started investing at the beginning of the 2008 financial crisis saw an average return of 150% by the end of 2015. This compares to an average return of 94% for investors who started investing in 2011, after the market had already recovered.
Another study by Vanguard found that investors who remained invested in the stock market during the 2008 financial crisis had an average return of 2.5% per year over the next 10 years, compared to investors who panicked and sold their investments, who had an average return of -7.5% per year over the same period.
Tying it all together
In conclusion, the best investors see recessions as opportunities for growth rather than reasons to panic. Investing during a recession can present advantages such as lower prices and valuations of stocks, potential for increased returns in the long run, possibility of acquiring undervalued assets, and less competition from other investors. However, investing during a recession also comes with risks such as the potential for continued economic decline, uncertainty and volatility in the markets, and the risk of investing in a company that may not survive the recession.
Strategies for investing during a recession include diversification, focusing on companies with strong fundamentals, taking a long-term perspective, and keeping a cash reserve for opportunities that may arise. Empirical evidence supports the idea that recessions can present opportunities for growth for smart investors.
So, if you're a long-term investor with a diversified portfolio and a cash reserve, don't let a recession scare you away from investing. Remember, the best investors see recessions as opportunities for growth, and you can too.
To Your Financial Success!
Jarrad Brown is an Australian-trained and qualified Fee-Based Financial Planner Global Financial Consultants Pte Ltd providing specialist financial advice and portfolio management services to Australian professionals in Singapore. Jarrad Brown is an Authorised Representative of Global Financial Consultants Pte Ltd - No: 200305462G | MAS License No: FA100035-3
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General Information Only: The information on this site is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision.
*Please note that Jarrad Brown is not a tax agent or accountant and none of the content outlined here should be taken as personal advice. You should consult your tax agent and financial adviser to review your current personal finances and financial goals to consider whether this strategy is appropriate for you.
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