Should you invest during a recession? COVID-19 has severely impacted the world's economy, causing a global recession. One of the best ways to take advantage of the recession is by investing, but is it really safe for you to invest during this period? There are many factors and strategies to consider before investing. Read this article to find what an expert had to say.
What goes up will eventually come down - the same can be said of the market when it's in a recession: one day stocks are soaring high, and before you know it, they come plunging to the ground.
Defined as a significant decline in general economic activity as reflected by the GDP, recessions are often characterised with rising unemployment, fewer available jobs in the market, increasing government relief like stimulus packages and unemployment benefits.
The recession that Malaysia is currently facing is a direct impact of the COVID-19 pandemic on the country’s economy, which has also curtailed key industries such as travel, leisure and hospitality, tourism, airline, retail and many more.
Also known as the ‘boom and bust,’ this period is often referred to as a period of rapid economic growth that is usually associated with rising inflation. (Image source: economicshelp.org)
In macroeconomics, economic slowdowns or downturns, experts say, tend to be cyclical, meaning they come and go every 8-10 years, and would last for between six months and up to two or three years before ending, and the economy returns to a period of economic growth.
Often, recessions make investors nervous, so much that they may start to wonder whether their portfolio needs some tweaking. Some may even abandon their stocks altogether when the market gets too volatile.
But despite market fluctuations, it’s important to remember that a recession isn't the time to bail out on the markets, as there is always an opportunity in every crisis.
Of course, we’re not saying you should dive into stock investing without any knowledge, instead, we’re advocating for seasoned and new investors to equip themselves with knowledge so they can make informed decisions and take tangible actions to develop an investment portfolio that is stable during a recession, and has the potential to grow incrementally over the long term.
Read also: 10 Things Successful Investors Don’t Do
Big disclaimer: all our views here are meant to be educational - not a professional recommendation from CompareHero.my.
Before we dive in, the main question still stands - what is the best investing strategy during a recession? Generally, the rule of thumb of investing in a recession is to maximize returns and minimize risks in ways that are comfortable for you.
To get a more informed perspective of investing in a recession, CompareHero.my spoke to a certified financial planner and personal finance blogger to help us get two different perspectives on investing during a recession.
Is it safe to invest during a recession?
The real truth: there’s no clean cut yes or no answer, as it’s a case by case situation depending on a person’s level of income, financial standing and background, type of investment and their risk appetite.
But during a recession, stock prices typically plummet, especially if they are part of recently hard-hit industries like travel, leisure, airline etc., opening up opportunities for the masses to pick up high-quality assets at discounted prices.
This presents the rare opportunity for investors to buy stocks for a much more affordable price. Phang Kar Yew, Executive Director and Co-Founder of Harveston Financial Group, echoed this point. He told CompareHero.my that investors should “never waste a good crisis,” because there will be opportunities in the market during a recession, depending on an investor’s level of perseverance, the risks, and how they welcome the opportunity.
Phang is a certified financial planner, who is also licensed by the Securities Commission Malaysia as a Capital Markets Services Representative and by Bank Negara Malaysia as a Financial Adviser’s Representative. (Image source: Phang Kar Yew)
For example, Phang said an investor looking to make a short-term return can take advantage of currently strong performing stocks like gloves - as long as the investor has some spare, non-emergency, cash on hand. The money, he said, has to be a dedicated amount that isn’t parked under any other commitments.
“During a recession, things are cheaper and companies are not sure of their pricing, so if you can hold your investment horizon longer, you may take up more risks. Equity will definitely pay more handsomely and provide better yield than fixed incomes or bonds in the shorter-term. But you have to match it with your objective and review every year or half-a-year to see if the market has turned around or is volatile. From there, readjust and rebalance the profile accordingly, “ Phang said .
However, he wanted to emphasize that the decision and desire to invest shouldn't just depend on the timeline or the performance of the market, because investing is not just about beating the market, but it’s mainly about achieving some form of personal or financial goal.
“We don’t invest because there is a recession or no recession. In investment, what we like to advocate on is to have a real clear goal and objective,” Phang said. “There is nothing better than defining what you want to achieve on the long term, mid term and short term.”
“With a very clear objective, then only will you be able to decide if it’s the right time to invest. It’s not so much on the external environment - yes, it does have a bit of implication, but it’s more about the inner self and the willingness to answer the question ‘why do we want to invest?’.” he added.
That view - that investing during a recession depends on an individual’s personal situation - is supported by Aaron Tang, the man behind Mr. Stingy, a popular personal finance blog that covers a variety of topics, including money, time, career and relationships.
Though Tang isn’t a certified financial planner and doesn’t have formal financial advisory credentials, he's gained an extensive following online from writing about personal finance on his blog, Mr. Stingy, in his spare time. (Image source: Mr. Stingy)
“People who are in comfortable situations (have a stable financial income and have emergency savings) can continue to invest even during a recession because investing is a long-term thing,” he told CompareHero.my. “Just because the market goes down one year doesn’t mean (you should stop investing.)”
“You’re not actively trading the market, because that’s something very different - I think most people who are investing are doing it for retirement or other longer financial goals, so over a longer period of time, it should work out okay,” he said.
Whether or not there’s a recession, for Aaron, the responsible answer to most investing questions would usually be, “it depends on your situation,” as he believes that there is no easy, clean cut, answer when it comes to investing.
Investing strategies - factors to consider before investing
When it comes to investing, ignorance isn’t bliss but a huge dent on your wallet. What you don’t know about investing, especially the basics, will cost you and may even result in catastrophic losses.
But not everyone needs a bachelor’s degree in finance or to be a certified financial expert to get their feet wet or hands dirty in investing. What you do need though, is the willingness and commitment to perform due diligence before committing to any major investment. This critical skill separates amateur investors from the professionals, and is what can make or break your portfolio.
By the way, hot tips and hunches, and relying solely on articles (like ours!) are not good examples of performing due diligence.
According to Investopedia, due diligence is defined as an investigation, audit, or review performed to confirm the facts of a matter under consideration. In finance, it essentially means requiring an examination of financial records before entering into a proposed transaction with another party.
It’s so crucial that there’s a law for it in the United States. Securities dealers and brokers are responsible for fully disclosing material information about the instruments they are selling, and the failure to disclose such information to potential investors made dealers and brokers liable for criminal prosecution.
Similarly in Malaysia, according to MahWengKwai & Associates, the onus of evaluating the merits of securities is placed on the investors, while applicants (ie. the target company) are also required to adopt high standards of disclosure when interacting with the market, for transactions that fall within the Capital Markets and Services Act 2007.
Bottom line: due diligence is important!
Here are some brief steps (not a complete guide) for due diligence that we can share from our own research:
1. Analyze the market capitalization of the company
A company’s market cap or total value can give you some insights into the company’s stage in business development - large cap companies tend to be more conservative owing to their less aggressive growth potential, compared to mid and small cap stocks which may be more volatile. This info also shows how broad the ownership is and the potential size of the company's target markets.
2. Understand the revenue, profit and margins trends
Go through a company’s financial statements to see how “healthy” they are as an organization. This helps you gain insights into how well a company makes and retains money. This information is important because it determines a company’s ability to pay investors dividends. Finding out how well a company uses its resources and much income it makes from operations can help you gauge how much return you’ll get in the long term, and how well the company is performing in the market.
3. Check out competitors and industries
Let’s take it up a notch and put your targeted company alongside its competitors and industry peers. By doing this, you get to see how it fares to similar companies within the same industry. This is where you discover if the company is an industry leader, its stability, and if they have specific target markets or cater to the broader society.
Proper leadership plays a crucial role in the performance of a stock.
4. Find out about corporate ownership and management
If you are going to own a slice of a company, it only makes sense that you want to know who is steering the ship at the top. Is the company led by a founder or is it professionally run? Most companies will share the bios of their management team online - there you get to assess their level of expertise and experience and can decide if they are proper leaders. Shareholders are best served when those running the show have a vested interest in the performance of the stock.
5. Calculate the Debt-to-Equity Ratio
Though all companies carry a debt on their balance sheet, you want to avoid companies with high amounts of debt. Compare the debt-to-equity ratio and find a company that has more assets than liabilities.
Invest if you can, but know your limitations
But it’s not enough to just go through publicly available information about companies, sussing and comparing company numbers, or performing a key competitor analysis, we also believe that due diligence extends to oneself. This means it’s also super crucial to assess your own capacity and capability as an investor.
With that said, it looks like we’ve rambled on for quite some time. Tune in to our next article if you want to find out how to assess your own capacity and capability as an investor and what types of investments to consider during a recession.
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