What Is A Recession And How Might It Affect My Investments?

The word recession has become more common in recent times, but what does it mean? Are we in a recession now and what can you do to ensure a better future?

 

What is a recession?

During a recession, the country’s economic output slows down, which can lead to companies struggling (although some may conversely do well). Unemployment usually rises, the value of assets and investments like property, stocks and bonds often decrease (although this is often in advance of the actual recession itself), while the cost of goods can increase.

Are we in a recession now?

In the UK, a recession is defined by 2 consecutive quarterly declines in GDP. As of August 2022, the UK is not in a recession as GDP grew during Q1 of 2022 compared to Q4 of 2021.

We are waiting on the release of GDP statistics for Q2, which, if they do show a contraction in GDP, would still require Q3 to also contract before we would officially be classed as being in a recession.

This means it is possible we are currently in a recession, but we won’t know it until December, when the Q3 GDP stats are released.

In the US this week, it was announced that their GDP had shrunk for the 2^nd quarter in a row, which means that, by the UK’s measure, the US would be classed as being in a recession.

Although this definition has been met, officially, it’s the National Bureau of Economic Research (NBER) that decide whether the US is in a recession or not. They do this based on lots of different factors and statistics, and, similar to the UK, it’s usually quite far into the recession that it gets officially labelled a recession.

How does a recession affect your investments?

In anticipation of a recession, the value of your investments will likely drop, and we have seen this happen in most stock markets year to date. The degree to which investments drop will depend on how much the markets drop, the funds you hold and the level of risk you take. Assuming you’ve made good investment choices, the lower the risk, the less value you will likely lose (you may even still make money) whereas, the higher the level of risk your portfolio takes, the more you are likely to lose during a recession in the short term.

Can you profit from a recession?

As humans, when we see our investments drop in value, the instinct is to sell to ensure we don’t lose more money.

To profit (or not lose) from buying and selling your holdings during a recession, you would have to sell your investments, hope the market drops lower and then buy back in at the lower price.

Psychologically, this is an extremely unlikely scenario as it is usually fear that leads you to sell your investments when they first drop in value. That fear is only going to be more exaggerated when the markets have dropped even lower.

This strategy’s success also requires the markets to drop further once you’ve sold to cash – what if you’re already at the bottom and the market is now going to recover?

Predicting the market in the short term is a fool’s game.

In the long run, the market has always gone up. The best way to profit during a recession is to hold your investments and wait for the recovery. Markets are often the first to react in anticipation of recession, and also the first to indicate when recovery is on the horizon. If you can invest more and take advantage of the lower prices along the way, brilliant.

Following the 2008 recession, the next 10 years had the UK’s FTSE 100 increase 100% from its bottom point and the US’s S&P500 increase more than 500%.

Following the brief Covid recession in 2020, the US’s S&P500 increased 100% and the FTSE 100 grew by almost 50%.

What should you do?

In short, the best thing you can do right now when it comes to your investments is hold on. The length of a recession varies dramatically so there’s no way of predicting anything with any accuracy. In 2020 the Covid recession lasted 2 quarters whereas in the ‘Great Recession’ of 2008, there were 5 consecutive quarters of GDP contraction.

If you’re at a stage where you draw income from your investments, protecting yourself from sudden drops in markets can be done in the form of lower volatility investments or having an allocation of cash to draw from in the short term. Your longer term invested money then has time to recover any losses it may be enduring.

If you’re at a stage of accumulation, time is your best friend. It may even make sense to put any spare money you have in and take advantage of lower prices. You almost definitely won’t buy at the very lowest price but it’s very likely to be worth more 10 or 20 years from now, when you may start to draw from your investments.