How to Invest During A Recession
“Moody's Investors Service a few weeks downgraded the long-term issuer and senior unsecured ratings of the Government of South Africa to Baa3 from Baa2 as well as the senior unsecured Shelf and MTN program ratings to (P)Baa3 from (P)Baa2, and assigned a negative outlook. The government's senior unsecured short-term program rating was also downgraded to (P)P-3 from (P)P-2. The rating actions conclude the review for downgrade that commenced on 3 April 2017”
This is an extract of an article in a business section of a newspaper I read the other day
as I’ve been looking at the current state of our economy, I realised that whether we like it or not the current downgrade will affect most of us.
I started looking at ways that could help me combat this current state of our economy in terms of investment choices I could start making. I'll be sharing what I’ve found with the hope that it will assist you. I've come up with two ways one could definitely consider when build his/her investment portfolio
Firstly, you need to build an emergency fund
“An emergency fund is an account used to set aside funds needed in the event of a personal financial dilemma, such as the loss of a job, a devastating illness or a major expense”. Note that financial institutions do not carry accounts labelled as “emergency funds”. Rather, the onus falls on an individual to set up this type of account and earmark it as money reserved for personal financial crises.
In my next article we will look at some of the practical ways to build an emergency fund.
Secondly, be smart when choosing an investment option.
As an investor you need to act cautiously but remain vigilant in monitoring the market setting for opportunities to pick up high quality assets at discounted prices. These are difficult environments, but they also coincide with the best opportunities.
During a recession as an investor you need to avoid the highly leveraged, cyclical and speculative assets: these assets are the worst performers in a recession. In these conditions, risk is rejected and chances of bankruptcy are increased. What does “highly leveraged mean? In simple terms it means to use more debt to finance something. What are cyclical and speculative assets? Again, in simple English, it is those stocks or investments that are highly correlated to the economic activity. Therefore when in a recession the profits and the value of your investments tend to drop.
On the other hand, counter- cyclical stocks or assets (which are also called Defensive stocks) do well during recessions. Counter-cyclical stock would be the opposite of cyclical stocks described above.
It is advisable for investors to become risk averse and subsequently move to safety. This means you need to choose less risky options to avoid the risk of losing.
In my investment portfolio I have unit trusts I bought from an Investment Management Company. I actually invested the same amount as my mom’s and we invested at the exact same time. However, I chose a more risky option and she chose a stable fund which is not risky. From looking at the movements from May to June, her investment value remained the same and mine has decreased by more than 2% of the invested value. This proves that my more risky investment was negatively affected by the change in the economic environment. I searched for a definition of unit trust and found a nice explanation from the old mutual website “Simply put, a pool of investors’ money is used to invest in financial instruments such as equities (shares) and bonds. This pool is then divided into equal units where each unit contains the same proportion of assets in the fund. Investors then share in the fund's gains, losses, income and expenses.
The wide variety of unit trusts means that they are an ideal way to build up a well-diversified investment portfolio tailored to meet your specific needs, risk profile and investment requirements.’ (I really hope this makes sense ). Ok Think of it like going in on a group gift. Taken altogether, those investments are called the fund's assets. Some of the benefits of unit trust are that they are easy to buy and sell and don’t demand a large up-front investment.
Investing in Stocks
When investing in stocks during recessionary periods, the relatively safest places to invest are in high-quality companies with long business histories, as these should be companies that can handle prolonged periods of weakness in the market.
For example, companies with strong balance sheets, including those with little debt and strong cash flows, tend to do much better than companies with significant debt and poor cash flows. A company with a strong balance sheet/cash flow is better able to handle an economic downturn and should still be able to fund its operations as it moves through the weak economic times. In contrast, a company with a lot of debt may be damaged if it can't handle its debt payments and the costs associated with its continuing operations. You can learn how to read and interpret financials on the Investopedia website (www.investopedia.com and search: how to efficiently read an Annual Report on their site). They have explained it very well there.
Investing in Fixed Income
Again, as investors become more concerned about risk, they tend to shy away from it.
Moreover, as investors sell these assets, they seek safety and move into Treasury bonds. In other words, the prices of risky bonds go down as people sell and the prices on Treasury bonds go up. But let’s look at the current economic conditions we are facing as a country. Faced by huge uncertainty, "Income funds are the preferred strategy at present," says Henk Viljoen, Stanlib’s head of fixed income and co-manager of the R23bn Stanlib Income Fund.The typical income fund is now yielding a net 8.5%-8.6% after costs, says Viljoen. An income fund is a type of mutual fund that seeks to generate an income stream for shareholders in securities that offer dividends and/or interest payments
Investing in property
A lot of people advise that one needs to shy away from investing in property during recession because of rising interest rates. I don’t believe in that. I do believe that one needs to be smart when taking this route. It is very important that as a property investor you set cash reserve to keep money that you could use if you experience severe loss of income and overrun of cost. Loss of income could be loss of your job or business income, loss or decrease of investment income i.e. loss of tenants. Overrun of costs can be increase of interest repayment from your mortgage, unexpected expenses etc. I have created a second savings account (under my normal account, thus avoiding extra bank charges for a separate bank account)/. Almost every month I transfer R100 in trying to build my cash reserve. How much is sufficient is quite a personal matter, but the general idea is: how many months you would like your cash reserve to last if you experience such severe loss of income. I think it is also worth mentioning that you choose fixed interest rates instead of variable rates when applying for your bond, thus during changes in the economic environment your interest rates will not change as you would have chosen a fixed rate
People have different attitudes towards the same situation; this will become more obvious during recession.
We all have friends and family who are not doing what we are doing, that is perfectly fine in my view; people are entitled to their preference and opinion, and we are not here to change them without invitation. I would just be more careful at whom I am listening to and whom I am getting advice from when it comes to property investing.
Henry Ford once said: "Whether you believe you can do a thing or not, you are right". So
• If you believe you can make more money from properties during recession, you are right;
• If you believe you cannot make more money from properties during recession, you are right too.
My advice: Remember not to keep your eggs in the same basket. Have different investment options in your investment portfolio but be wise and vigilant and move your investments around whenever you are expecting economic changes especially drastic changes like a recession. Given an option to sink or to swim, chose to swim.