The US is officially in one recession. The gross domestic product fell by 5% in the first quarter of 2020 and by 32.9% in the second quarter, which corresponds to the official definition of a recession National Bureau of Economic Research confirmed that February marked its beginning.
If you are lucky enough to have extra money now (let’s face it, a lot of people aren’t) you may be wondering whether it is better to save or benefit from as much as possible Market downturns by investing.
Here’s what you should do to protect yourself during this time of uncertainty.
How much should you have saved during a recession?
As you may have guessed, saving money is never a bad idea. “Focusing on savings is usually one of the smartest money decisions a person can make regardless of where we are in a market cycle,” said Lauren Anastasio, Certified Financial Planner at SoFi.
Cash in the form of a Emergency fund is always recommended. Typically, you should save three to six months worth of expenses. “I often recommend a three-month emergency fund for renters, double-income households or those with highly transferable skills that make finding new employment easier if they lose their job,” said Anastasio. “The essential six-month spend is more appropriate for homeowners, households with an income, and those with children or other dependents.”
However, Anastasio said that when we enter a period of lower employmentIt is a good idea to have the greatest financial cushion possible.
“While unemployment is set to rise, even those fortunate enough to feel secure in the workplace are not immune to recession-induced cuts and their incomes can still be at risk,” said Anastasio. “You may find that planned salary increases stall, your bonuses may be cut, and overtime is harder to come by.”
If you are self-employed, have very good niche knowledge, or are retired, Anastasio says you may want to keep essential expenses in your emergency fund for up to 12 months.
Banks and lenders also tend to tighten their lending standards during periods of recession. That means loans and lines of credit, including credit cards, could be a lot harder to come by. Having enough cash on hand will not only prevent you from building up debt in a financial emergency. This may be your only option to cover expenses when credit is not available.
A high yield savings account is usually the best option to keep your money in store. Savings account interest rates are pretty dire these days, but the main goal should be to keep your savings liquid, easily accessible, and protected from risk.
Is Now a Good Time to Invest?
Once you’ve built your emergency fund (and paid off high-yield debt), the next step is to put your extra cash into investments that can provide you with higher returns over the long term.
Depending on your personality, this idea can cause panic. During the 2008 recession, the market roughly lost 40% on an annual basis. Most recently, COVID-19 drove the market down more than 30% between February and March. “When you look at these numbers, there may be an urge to take your money and run,” said Mindy Yu, director of investments at Hide. “If you take a step back and look at market performance through the 2008 recession, through COVID-19, and to this day, you will find that it has actually increased more than 6% on an annualized basis.”
On the other hand, you might be amazed at the prospect of timing the market or guessing the next hot stock. Research shows, however, that these are individual investors pretty bad at that. There is no doubt that buying during a market downturn is a great way to increase your future returns. However, you should invest consistently and methodically no matter how the market is currently performing.
“The only thing that is predictable about the stock market is that it will go up and down,” said Yu. “There is no crystal ball that can predict exactly what will happen in the future, so it can be critical that investors diversify their portfolios and accounts.”
One way to stick to a simple, disciplined investment strategy is according to Yu Averaging the dollar cost. This involves investing a set amount of money at regular intervals. For example, you could decide to invest $ 200 every month. This means that you buy more stocks when the market is down and fewer stocks when the market is up.
This allows you to participate in different stock prices during the different investment cycles and ultimately prevail. “That way, you can remove the emotional aspect of the timing of the market and increase your time in the market, increasing the potential for growth through the power of compounding,” said Yu.
In addition to averaging the dollar cost, there are a few more steps you can take to maximize your investment.
Keep an eye on diversification: You probably know you don’t have to put all your eggs in one basket, but diversification means a lot more than choosing more than one investment. It’s also important to diversify across different investment types such as stocks, index funds, and bonds, as well as your portfolio concentration. For example, Yu said there was a general tendency to focus on US companies. However, other regions develop differently in different business cycles and economic crises. So it makes sense to take these into account too. “It’s important to diversify not just how you invest, but where you invest,” she said.
Understand your goals and your time horizon: Before throwing your money in the market, consider why you are investing in the first place. Are you saving for a home in the next five years or for retirement in decades? If you’re young and saving for long-term goals, your portfolio may have a larger percentage of stocks in it. If you are saving in the short term, consider choosing lower risk investments like bonds.
Review your portfolio and rebalance as needed: “Movement in the market with uncertainty can dramatically change your portfolio allocation, exposing you to risks you may not be aware of,” said Yu. Over time, your investments may no longer align with your risk tolerance and goals. It is therefore important to regularly review your portfolio and rebalance if necessary. “Rebalancing can bring your asset allocation back into line by selling overweight assets and buying underweight assets now,” said Yu.
Remember, it’s okay to start small: One of the biggest misconceptions about investing is that you have to have a lot of money to get started, Yu said. However, thanks to the power of compounding, even the smallest investments can grow significantly over time. Regardless of how much money you can invest, the sooner you start, the more you have to win.
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