If you should learn how to invest during a recession, the short answer is yes.
In fact, recessions present a golden opportunity to make money in the stock market, as the market is resilient and over time will rebound.
Therefore, there are actions you can take during any recession to secure a financial future.
Should You Invest During a Recession?
Investing during a recession can seem counter-cultural, but for Rule #1 investors and experts like Warren Buffett and Charlie Munger, there is no better time than an event such as this one to invest.
In this blog, I’ll outline my proven techniques for investing during a recession, so you can take tangible action now to develop an investment portfolio that can not only remain stable during a recession, but also has the potential to grow incrementally over the long term.
It’s worth saying, before we dive in, that you should always apply Rule #1 principles in investing, even with options – because if you wouldn’t want to own a company for 10 years, you shouldn’t own it for 10 minutes.
This blog is meant only for education and entertainment purposes- nothing I discuss is my advice or recommendation.
With that out of the way, let’s get started.
How To Invest During A Recession
Investing during a recession is not as scary as you may think. In fact, it’s far more manageable for people who have the cash, have done their research, are patient, and are paying attention.
But as an investor, having an investing strategy during a recession is key to help guide you as you go along with your investment decisions.
If you follow these steps you can master investing during a recession with ease.
Step 1: Get Into Cash
In order to invest, you first have to have the funds to invest. This is why I highly encourage you to have cash on hand during a recession (or more ideally before the recession) so you can be ready to invest it when the time is right.
It’s more important now than ever to save and spend your money wisely. The more you save and the less you spend on luxury or non-essential items, the more cash you will have to invest.
Unemployment Will Rise
Recessionary times and unemployment go hand-in-hand. During any recession, it is likely that the unemployment rate will rise.
This is even more reason to have cash on hand and be frugal with your spending. If you can live on less, you will have more to invest.
Step 2: Find Recession-Proof Rule #1 Companies
Once you’ve established some cash, you can start to consider what to invest it in. When searching for stocks to buy during a recession, you’ll want to find “Rule #1 Companies”.
The best stocks to buy during a recession are ones that meet the 4 M’s of Rule #1 Investing requirements:
- Meaning: The business has meaning to you and you understand the value it offers.
- Moat: The business has an impenetrable advantage over the competition that keeps them from having to compete on pricing.
- Management: The business is led by people with competence and integrity who have the capacity to lead the business through a recession.
- Margin of Safety: You can buy the business at a “sale” price that all but guarantees a 15% annual return over the next ten year period.
It is always important to purchase stocks that follow these Rule #1 principles, but especially when you are considering the best stocks to buy in a recession. Companies that do well in a recession will meet all of these criteria.
If a business checks off these 4 M’s for you, add it to your “watch list”. This is the list that you will refer to when you are ready to invest and when the price is right.
For more tips on how to pick companies for your watch list, check out this complete guide for finding stocks in 2021.
Step 3: Research, Research, Research
It is always important to research any company you plan to invest in, but especially important when investing during a recession.
So, what looks different during a recession? A company’s response to recessionary times is telling as to their success thereafter.
Here are a few things to focus on:
- Any news around the company to see how it plans to stay profitable during the recession.
- The recession’s impact on the company’s industry as a whole.
- The areas you’re interested in, passion about and spend money on, which we refer to as one’s 3 Circles of Competence.
Being able to understand the business you want to buy, how it is affected by the recession, and how it is responding is key to smart investing during a recession.
How will the business and industry be affected by a long-term economic downturn? As companies continue to experience the effects of closures, the significant decrease in household spending, and the reallocation of resources, we expect to see greater losses.
Profit losses affect us as investors and how we determine which businesses we want to own long-term—or not. This information helps us discover which companies will survive potential future economic downturns and which will not.
Step 4: Invest in Your Education
If you are feeling in over your head, don’t worry.
Put the pedal to the metal and educate yourself on how to invest money so you can succeed in any market condition.
And if you’re reading this, you’re already doing great. Continue to prepare yourself by monitoring the activities expert investors, researching companies in your circle of competence, and participating in investment trainings – such as our Live 2-Day Virtual Investing Workshop. I’d love to see you there!
Step 5: Get Your Watch List of Companies Ready
Once you have educated yourself and done extensive research to discover the companies that are Rule #1 businesses, you can create your watch list. This is the exciting part!
Your watch list is a list of recession-proof companies you are confident in that you are ready to pull the trigger on when the price is right.
Step 6: Be Patient
Once you have your watchlist ready, it’s understandable that you will be eager to invest right away. But patience is a virtue and one of the best virtues you can have when you are investing during a recession.
You’ve got the cash, you’ve done your research, you have a watchlist of companies, and now you wait until you have the right margin of safety price. If you’re following the Rule #1 principles it should be like buying a 10 dollar bill for $5.
So, that’s the first part – wait for the right price. But you may also wait to put all your money in.
When investing during a recession, start by investing 25% of what you intend to invest and see what happens. There is nothing wrong with dipping your toe in the market to ensure you are making the right move. When the stock of a business on your watch list hits your “buy” price, it’s time to buy.
Step 7: Monitor The Action of Experts
The actions of experienced Rule #1 Investors can help signal when to buy, sell, or what to look out for. These people have been at this a long time, so you can learn a lot from the decisions they have made and are currently making.
Pay attention to investment gurus you trust and watch how they are buying stocks during a recession—or not buying.
For a few of my favorite gurus to follow, watch this video below.
Warning Signs to Avoid in a Company During a Recession
We have talked about what to look for to find recession-proof rule #1 companies, but there are a few red flags we need to talk about as well.
While a lot of companies are on sale during a recession, that doesn’t necessarily mean they are a good investment.
Here are a few things to look out for before you invest in a company during a recession.
Beware of Companies with Debt
Companies with debt are in dangerous territory when a recession hits and bankruptcy is a very real possibility.
It is important to research how much debt the company has and how it compares to the company’s earnings. Free cash flow is a great indicator of a company’s health when it comes to debt.
You can calculate its free cash flow like this: First, find the company’s operating cash on its cash flow statement. Then, subtract “Purchase of Property & Equipment” from operating cash flow. This number equals the company’s free cash flow.
Next, divide the free cash flow by the total long term debt (found on the balance sheet) to determine how long it will take the company to pay off its debt.
If a company cannot pay off its debt in a short number of years, we’re talking two-three, it is a bad sign.
Ideally, you would only invest in a company that has zero debt, but if it has enough free cash flow to pay off its long-term debt in a few years, it can still be considered a Rule #1 business.
Avoid Management that Poorly Allocates Capital
A recession-proof business needs to have a team of leaders who are invested in the company and will lead it through uncertain times.
One indicator of good leadership is how they allocate capital. In order to judge whether the management allocates capital properly, you have to look at when they are buying back stock.
Are they buying back stock at its highest price? Steer clear of these companies.
This is a sure sign that the leadership is more interested in protecting themselves individually than the company as a whole.
Don’t Invest if You Can’t Determine Long-Term Value
With any investment, you need to know the long-term value of that company, but this can be difficult to determine during a recession.
We are going to assume that every company we are looking at will experience some sort of negative impact because of the recession.
But if it has a big moat, no debt, and allocates capital well, it should be able to come out on the other side.
We only want to invest in recession-proof companies that meet these criteria.
If a company meets these criteria, we can determine its long-term value like this: First, we assume the business will experience hard times over the next few years, but that it will stabilize with the economy in approximately 5 years. After 5 years, we can expect the company to continue at a decent growth rate and calculate its long-term value based on that.
If you can’t determine the long-term value of a business, you should be patient, continue to do your research, and watch the stock market and how businesses respond.
Don’t be in a rush to jump in, but instead focus on understanding everything you can about the businesses on your watch list.
Best Stocks to Buy During A Recession
Now that we have covered how to invest during a recession, we can dive into what to invest in.
To recap, the best stocks to buy in a recession fall into your circle of competence, have a big moat, have a great long-term value, and are on sale.
Counter-cyclical stocks are stocks that appreciate in price during recessions, meaning the stock’s price will move in a direction that is opposite to the general market trend.
Keep your eyes out for stocks with the best balance sheets, low (or no) debt, healthy cash flow, and are in industries that historically have done well during major events.
Here are a few categories to look into.
1. Essential Goods
Goods that will remain valuable both during and long after a recession. Think of tangible items such as energy, food, and household products that we will always need.
2. The Big Players
Companies with a big edge on the competition that will be able to raise prices with inflation. Think of businesses such as Costco and Amazon.
These companies have a big moat that will sustain them throughout recessionary times and after.
3. Small Luxuries
Consider small luxuries that people will still hang on to even when times are tough.
When we look back on The Great Depression, we see how people still attended movies for a semblance of normalcy.
What are those little luxuries nowadays that society will cling to?
4. Proven Recession-Proof Companies
Look at companies that have strong histories of thriving after past market declines. Look for companies that were around during the great market decline in 2007 and check out how they performed during and after 2008.
Did they come out ahead when the recession was over? Or were they really weak when it was over? If they did great, that’s a good sign they might be able to come out on top again in the future.
Is a Recession Likely in 2021?
This year is a special case where many people are facing unemployment, homelessness, and major health emergencies due to the COVID-19 pandemic.
The U.S. lost 140,000 jobs in December of 2020, and many companies have taken on debt.
If interest rates go back up, or if trade wars push revenues down, these companies are vulnerable to going bankrupt. That could set off a ripple effect of bad news as even more people lose their jobs and run out of money.
There are also many major political changes on the horizon that might impact the stock market including policy changes, tax changes, and newly passed propositions.
This is why it’s more important than ever to learn how to invest in any market condition!
Want to Learn More About How to Invest During a Recession?
If you want to learn more about investing during a recession and how to build a recession investment strategy to set you up for success, join me for a Live Virtual Workshop.
On top of that, you will have an opportunity to tackle your stumbling blocks by having live sessions with a Certified Rule #1 Coach. Hope to see you there!
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.