From worries about job security to the sinking feeling caused by shrinking balances in your retirement accounts, there are plenty of negative consequences of a recession. However, an economic downturn is not the end of the world. In fact, recessions are an inevitable and necessary part of the economic cycle.
History has shown that, when it comes to the financial markets, what goes down eventually comes back up, although the road to recovery may be a bumpy one. And while it may seem counterintuitive, recessions aren't all bad news. From the chance to earn higher yields on your savings account to the potential for bargains and low-cost dividends in the stock market, the clouds that settle over the economy during a recession do in fact have a few silver linings.
Key Takeaways
- Recessions have plenty of negative consequences, but they can provide a necessary reset for the markets.
- Higher interest rates that often coincide with the early stages of a recession provide an advantage to savers, while lower interest rates moving out of a recession can benefit homebuyers.
- Investors may be able to find bargains on assets that have decreased in price during a recession.
Correcting Market Imbalances
A recession resulting from an economic imbalance may rectify it, clearing the way for a return to growth. For example, the 1981-1982 recession, which was triggered by Federal Reserve interest rate increases in response to high inflation, helped to lower the inflation rate from 11% in June 1979 to 5% by October 1982, and the U.S. economy grew for the next eight years.
Similarly, a recession can end the misallocation of investment capital, whether fueled by a housing bubble or a dot-com one. Although the process can be painful for many investors, recessions may be instrumental in bringing the markets back down to earth, setting the stage for an eventual recovery, and renewing the foundations for economic growth.
Incentivizing Savings
The early phases of an economic downturn often coincide with increases in interest rates as the Federal Reserve pulls the levels of monetary policy in an attempt to combat inflation. For example, in 2022 and 2023, the Fed lifted the federal funds rate, a key overnight lending rate, 11 times to a range of 5.25% to 5.5%, where it currently sits. While rate hikes may have a cooling effect on the economy, there is a bright side, as the higher rates translate to higher yields on deposits in savings accounts.
While other assets may be subject to heightened levels of risk as the economy tumbles, savings accounts benefit from the higher interest rates during the early stages of a recession, providing stable returns. Savings vehicles like certificates of deposit (CDs) and money market accounts may offer even higher rates than traditional accounts, and online accounts often have the best terms, so it's important to shop around before stashing your cash.
The advantages of higher savings account rates make this stage of the economic cycle a perfect time to focus on beefing up your emergency fund. This way, if you lose your job or suffer another economic setback during the recession, you will have a cushion of cash on hand to pull through the difficult time. What's more, you can use the cash you accumulate in your savings account to allocate to other investments as the economy begins to recover.
If the higher rates aren't enough, depositing your money in a savings account can help you rest easier during a recession because the funds are insured by theFederal Deposit Insurance Corporation (FDIC).
Bringing Bargains to the Market
Recessions can be a stressful time for investors. To put it simply, it can be quite distressing to watch your portfolio shed value as the economy takes a dive. This is especially true for retirees or those nearing retirement who don't have the luxury of time to recover from investment losses. However unsettling it may be to see all that red ink on your account statement, it's important to avoid overreacting and selling your assets at their recession-induced lows. In fact, if you have the patience and are able to adopt a long-term perspective, a recession can be a good time to hunt for bargains and purchase undervalued assets.
In addition to identifying stocks of resilient companies that may have suffered overblown declines, investors who continue to buy through a recession stand to benefit from lowering the average cost paid for their assets. For example, if a stock you own has lost value during a recession but you remain bullish on the company's outlook, you could buy additional shares at the reduced price. This will bring down the overall cost per share that you paid for your position, making it easier for you to break even and setting you up for extra gains when the stock recovers.
Declining stock prices during a recession also have the potential to benefit investors seeking income from dividends. As the price of a stock decreases, its dividend yield increases, generating higher returns for shareholders. However, the perks of increased dividend yield come to fruition only if the company maintains its dividend, despite the recession's potential negative impacts on its business. While such due diligence is important any time you are researching a dividend-paying stock, it is particularly critical during a recession to seek companies with a history of stable payouts and the capacity to weather the current downturn.
Purchasing shares of index funds and exchange-traded funds (ETFs) can be one way to mitigate the risk of investing during a recession. If you invest in individual stocks, there is a chance that the company you choose may post outsized losses or even fail to survive the downturn. On the other hand, pooled index funds and ETFs offer built-in diversification that enhances your chances for weathering the recession.
Foreshadowing Lower Interest Rates
In contrast with the interest rate hikes that often accompany the beginning of a recession, the later stages of an economic downturn frequently see policymakers lower rates in a bid to jumpstart the sputtering economy. While vehicles like savings accounts lose much of the appeal they generated earlier in the downturn, there are other advantages to the prospects of lower rates on the horizon.
For instance, a lower fed funds rate translates to lower mortgage rates. The favorable borrowing environment during the later stages of a recession could provide an excellent opportunity for homebuyers.
What Is a Recession?
A recession is a substantial, broad-based decline reflected in numerous indicators of economic performance and typically lasting longer than a few months.
Can I Benefit From a Recession?
By their nature, recessions have far-reaching consequences, with negative effects spanning multiple areas of the financial markets. Although it is impractical to expect to reap a financial reward from a struggling economy, recessions have a few silver linings. Heightened interest rates at the beginning of a recession may allow you to earn more on your savings deposits, while lower rates moving out of the recession may provide opportunities to secure a favorable mortgage loan. You may also be able to buy assets at a discounted price after they have depreciated in value.
How Do I Manage My Portfolio During a Recession?
If you have a longer investment horizon that will give your assets time to recover from any losses during the recession, you may benefit from maintaining your existing asset allocation, remaining invested in the markets and poised to gain from an eventual recovery. However, there are ways that you can reduce your portfolio's risk in response to an economic downturn. Riskier assets like stocks and high-yield bonds tend to lose value in a recession, while assets that are seen as more stable like gold and U.S. Treasuries tend to appreciate. Within the stock market, shares of large companies with solid cash flows and dividends tend to outperform in downturns.
The Bottom Line
Recessions are a natural, unavoidable stage of the economic cycle that invariably brings hardship to individuals who lose their jobs or businesses. Economic downturns can also be a difficult time for investors, especially people nearing retirement who can't afford losses in their portfolios. However, for those with the flexibility to adopt a long-term perspective, recessions have a few silver linings.
It's difficult if not impossible to time the bottom of the market, but depressed asset prices during a recession could offer buying opportunities for investors. Shifts in interest rates throughout the course of an economic downturn also provide certain advantages—higher rates aimed at fighting inflation benefit savings deposits, while lower interest rates implemented to spur a recovery make it cheaper to take out a loan. Although they don't make up for the economic pain experienced during a recession, these bright spots could be helpful in weathering the storm and positioning for an eventual recovery.
