Key learning points
- It is possible to make money in a falling market. You just have to be more strategic with your plans.
- Avoid speculative stocks. Instead, invest in high-quality companies.
- Consider selling options and investing in actively managed funds to get decent returns during a weak market.
As recession fears mount, more investors are wondering how to recession-proof their investments. Is there a way not to lose money in a falling market? Are some investments better than others?
Here’s what you need to know to protect your wealth during a weak economy and falling stock market, and how you can potentially grow your wealth.
Investing involves risk
It is important to understand that the only way you can eliminate 100% of the risk of losing money when investing in the stock market is by not investing at all. When you buy an investment, whether it’s a stock, bond, mutual fund or exchange-traded fund, there is a risk that it may fall in value.
Although you cannot eliminate this risk, you can reduce it by investing strategically. Read on for advice on steps you can take to keep your money safe and growing, even when the stock market isn’t rising.
That said, here are the steps to consider if they make sense for your risk tolerance and fit your investment goals.
Don’t go all in
It can be tempting to put all your money into the market when it’s low, but this could be a silly mistake. First, the market looks cheap based on where it was. If a stock was trading at $200 per share and is now trading at $75, is it cheap?
Based on price alone, the answer is yes. But you cannot buy investments this way. You also need to look at business and the economy. The stock could have traded as high simply because of a one time event or because of irrational investors.
Take Peloton for example. When gyms were closed, the best option for working out at home was the experience Peloton provided. As a result, sales were abnormally high, as was the share price. But now that gyms are open again and people have more options to exercise, sales of Peloton are declining. The stock, which once traded at more than $160 per share, is now trading at less than $10.
Is it a buy? Based purely on the share price, it seems like a bargain. But what are the chances of it trading at $160 again?
The same goes for the market as a whole. While a pullback from its all-time high may seem like a buying opportunity, with the risk of a recession on the horizon, the market is much more likely to fall than to go back up and surpass the all-time high. at least in the short term.
At the end of the day, you don’t want to make the mistake of thinking that a down market is temporary when it could be longer than expected.
Don’t try to time the market
If going all-in isn’t smart, you might think it’s wise to wait for the market to drop a certain percentage. The problem here is that nobody knows where the bottom is. A few people may get lucky and invest at the absolute bottom, but most people don’t. It’s like playing the lottery. A few people win, but most of the others lose.
Look back at the market during the start of the pandemic. The S&P 500 index closed on February 14, 2020 at 3,380.16. A month later, on March 13, 2020, it had dropped to 2,711.02, a 20% drop.
Most people probably thought that was as bad as it gets. But the market didn’t bottom out until March 20, closing at 2,304.92, down 32%. Where do you think the market will go after this amount drops in about a month? Most people were scared at this point, assuming that the market would continue to fall as it had only fallen 10% in a week. But it did just the opposite. It peaked on December 31, 2021 and closed at 4,766.18 for a gain of 52% from its low on March 13, 2020.
Since no one knows when the market will bottom, the best option is to use a dollar-cost averaging strategy. To do this, you invest a small amount over a period of time to smooth out the movements of the market. For example, if you have $10,000, you can invest $2,500 each month for four months, or you can invest $1,000 each month for 10 months.
Dollar-cost averaging reduces risk by buying fewer shares when prices are high and more when prices are low. Note that this is a great strategy in a weak market, but not so great in a bull market environment.
Diversify your investments
Another crucial tip for recession-proofing your investments is diversification. This means you buy stocks in a variety of industries and may even want to consider adding bonds to your allocation. The more diverse you are, the less risk you take.
The biggest mistake people make when it comes to diversification is thinking that buying shares of two companies in the same industry is a form of diversification. That’s not it. Yes, you spread the risk from one stock to two, but if the industry takes a turn for the worse, chances are both stocks will fall in value.
A great way to look at this is to pretend you’re an artist and want to take a picture. Diversification means having access to crayons, markers, crayons, paint, charcoal and more. You have many options if any of these mediums are not ideal. This is what it’s like to invest in stocks across different industries. If you only have a red crayon and a blue crayon, you have different colors. But if you don’t want to use crayons, you’ll have a hard time creating the image.
We all want to make a good deal and now might seem like a good time to take some risks with certain stocks. But a negative market is not the time to speculate. Chances are bad news will come out and sink the market.
Although bad news can come at any time, you should consider this phenomenon. If things are going well in your life and you get some bad news, you can usually handle it and it won’t have a significant impact on your life. But when you’re struggling and you get bad news, the news has a bigger impact. It’s all about your mindset.
This is the same as the market. When the economy is strong and bad news comes unexpectedly, the market reacts and often shakes it off. But when the economy is weak and bad news comes out, the market embraces it and falls.
If you are speculating during this time, you can lose a lot of money quickly. You are better served choosing high-quality investments and waiting to speculate until things improve.
Invest in dividend-paying stocks
Speaking of quality investing, dividend stocks should be at the top of your list. These stocks have strong balance sheets and a long history of stable income streams. When the market falls, these stocks tend to outperform. Not only are these companies more likely to survive, but you also increase your returns by getting a dividend paid even if stock prices fall.
The best place to research companies that pay dividends is to look at the Dividend Aristocrats List. This list includes companies that have consistently paid and increased their dividends for 25 consecutive years. If you don’t want to invest in individual stocks, there are mutual funds and exchange-traded funds that invest in high-quality, dividend-paying companies.
Take advantage of options
Options, especially call options, allow you to earn a small income on the stocks you currently own. A call option works by offering your shares to another investor at a specific time for a fixed price. The buyer pays you a small fee or premium in exchange for this option. If the stock does not trade at or above the agreed price on the specified date, you keep your shares and the premium. If the shares trade at or above the set price on the agreed date, you sell your shares to the buyer at the agreed price.
You run little risk since you own the shares. The only risk you run is that the stock will be worth much more than you think by the time the option expires.
Consider actively managed funds
While many experts recommend that the best option for retail investors is to invest passively through an index, now could be a good time to consider actively managed funds. This is because these funds are more likely to outperform the stock market.
When the market continues to move higher, it is difficult for managers to find undervalued stocks to invest in that offer higher returns than the market. But when the market goes down, things get much easier. Market returns will be low, so even picking a few stocks that perform well can provide better overall returns. Granted, the cost of investing in these investments is higher, but the larger profits can offset this price difference from the market.
it comes down to
There is nothing you can do as an investor to avoid losing money when you invest in the market. But this shouldn’t stop you from investing, even during a recession. If you put in some work and invest strategically, you can preserve and grow your wealth regardless of market conditions. Plus, Q.ai is here to help with AI-powered investment kits that do the legwork for you.
Download Q.ai today for access to AI-powered investment strategies.