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Recession Proof

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It seems like you can’t read an article about the economy that is not mentioning the looming recession facing our country.  While no one knows what the future holds and the United States is not yet in a recession, I thought it would be helpful to lend some historical perspective to what a recession could mean to equity investors.

If history is any guide, and you plan on buying equities through your 401k or other periodic investment plan over the next ten years, you should be ecstatic that we could be entering a recession.  Before you call me crazy and stop reading the article, let’s look at the data:

S&P 500 Index

Post World War II Recession Data

What the data shows is that when the stock market peaks going into a recession, on average, the downturn lasts 12 months and investors lose 16 percent of their capital.  Looking further down the road, for the investor who was unfortunate enough to invest his money in the month the stock market peaked, there is a silver lining:  on average, five years after the peak, the investor would have 68 percent more than he started with, and ten years later he would have almost two and a half times his original investment.

Net buyers of stocks

So what does this mean for you?  First, if you are a net buyer of stocks, meaning that you are going to be buying more stocks than you sell over the next five to ten years, the recession should not worry you.  There has only been two periods during the last 10 recessions that the market was not positive the five years after the market peaked.  There has never been a ten year period immediately following the peak of a market before a recession, where the market was not positive.  The moral of the story:  even though you are scared, keep buying.  If you have a 401k or automatic investment plan, history tells us that recessions are some of the best times to buy equities.

Net sellers of stocks

But what if you are going to be a net seller of stocks over the next five years?  For those individuals who are retired or plan on liquidating their equities over the next few years, the strategy changes.  If you are not prepared to hold on to your stocks for at least five years, you should reconsider your allocation.  Our advice to clients who are retired or have upcoming cash flow requirements that will be funded through their assets is to have at least five years of expenses in cash and bonds to avoid being forced to sell your stocks at a low price.  If we do go into a recession, and the stock market loses value, those investors should use their cash and bonds to fund their expenses, holding their stocks for the expected future jump in value.

If the United States does go into a recession it won’t be the first or last we experience over the decades to come.  To be a successful investor, you need to know how to handle periods such as these, by using discipline rather than emotion.

The information in this article is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for financial planning or investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

07/20/2011 Tagged , ,


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