Investing During A Recession – How Investors Build Up Wealth In Times Of Crisis

Investing during a recession sometimes takes a lot of courage, but can be worth it. In this article, I will show you how investors repeatedly manage to create wealth in times of crisis. I will discuss the most important questions you will face when you think about whether or not you should invest money during a crisis. 

Investors key takeaways:

  • Yes, it is possible to lay the foundations for future prosperity in crises or recessions. Investors like Irving Kahn or Warren Buffett have shown how it’s done.
  • Anyone who invests during a recession bears the risk of a complete loss, just like in a bull market. But if you assume that prices will rise again in the future (as they have always done so far), then every crash brings you closer to the final bottom of the recession from which prices will rise again.
  • Gold and precious metals can hedge your portfolio in crises. Over a long period of several decades, however, gold has underperformed the broader market.
  • Real estate can also be an option. In times of crisis, they tend to lose value and thus offer favorable entry opportunities. REITs have even outperformed the broader market.
  • Overall, I think it is a good idea to invest broadly in the market and especially in stocks with a defensive business model. Here you also have the opportunity to make diversified investments in the real estate sector.
  • It is essential that you know the risk profile of your investment. In any case, you should always carry out thorough due diligence before you invest.

Is it possible to make money during a recession

Yes, it is possible to make money with investments, even in a recession. In a recession, prices are sometimes extraordinarily volatile and driven by emotion. Greed and fear fluctuate back and forth and can quickly drive stock prices up or down by 10 or more percent. Especially in phases of fear, investors often find absolute bargains.

It is important to know and understand these different phases of greed and fear. While they are perfectly normal during market circles, they show quite well where markets are overvalued and where stock prices have already priced in a lot of risks.

Times of greed

In times of greed, stocks are particularly popular, and greed drives many investors into the markets. Rising prices can then quickly lead to a self-fulfilling prophecy. Such a period of euphoria is characterized by certain narratives, which can help identify greed:

  • “This time, everything is different.”
  • “The comparison to other bubbles does not fit.”
  • A high degree of optimism.
  • “There is still a lot of potential.”
  • “Company A or B is disruptive.”
  • “Multiples like P/E ratio etc., are no longer relevant today (this time, everything is different).”
  • “The skeptics don’t understand the stock markets, or they have gone short.”

In such phases, investors are fully in risk-on mode. This is a warning sign because in many cases they ignore the risks.

Times of fear

Then there are periods of fear and anxiety. In phases of fear, the sentiment changes completely. Investors are suddenly afraid of losses. They become extraordinarily risk-averse and pull their money out of the stock markets. Here, too, individual narratives prevail in times of fear:

  • “This is just the beginning. The worst is yet to come.”
  • “A stock that falls 90 percent can fall another 90 percent.”
  • “The stock markets are a casino.”
  • “I prefer to wait for the bottom before investing.”
  • “I don’t think we’ll see the old all-time highs again for the next 10, 15 years.”

Economic crises often occur during such phases. The profits and losses of companies collapse. It looks like everything is only going to get worse. Suppose they do, only the incredibly courageous invest such as institutional investors. In such phases, private investors, in particular, tend to remain on the sidelines.

Who made money during a recession

It is worthwhile if you can read the market sentiment correctly. It protects you from unconsciously becoming a slave to the emotion-driven herd. Likewise important is that you can lay the foundation for future above-average growth phases of fear.

In every recession, some courageous investors invest diligently and end up making millions or billions. Take the Great Depression (1929-1932) or the Great recession in the wake of the financial crisis (2008/2009) as an example. These two legendary OGs of investing are thus representative of all the other brave investors who made a fortune during a recession.

Irving Kahn

Investing During Recession - How Investors Build Up Wealth In Times Of Crisis Quote
Legendary Irving Kahn: Investing During Recession – How Investors Build Up Wealth In Times Of Crisis

Irving Kahn started his investment carrier as an assistant to Benjamin Graham at Columbia Business School in 1928. In the summer of 1929, some months before the great crash in September, he made his first short sale.

He had noticed an overvaluation in the stock markets due to the high price gains and had bet on a broader stock market crash. As a result, his initial investment of $300 (today about $4000) doubled while the stock market crashed. That is what Kahn said about this time decades later, looking back:

“I wasn’t smart, but even a dumb young kid could see these guys were gambling. They were all borrowing money and having a good time and being right for a few months and, after that, you know what happened.”

Warren Buffett

Warren Buffet: Investing During Recession - How Investors Build Up Wealth In Times Of Crisis Image
Warren Buffett: Investing During Recession – How Investors Build Up Wealth In Times Of Crisis Image

In October 2008 (i.e., almost half a year before the stock markets bottomed out), Warren Buffett explained in an excellent article in the New York Times why Americans should invest in stocks. The following stock market wisdom inspired the legendary Oracle of Omaha:

Be fearful when others are greedy, and be greedy when others are fearful.

Buffett signed a contract in 2011 to invest $5 billion in Bank of America. At that time, the bank was still suffering severely from the consequences of the financial crisis and was in urgent need of liquidity. So Buffett was willing to help. In return for his investment, he received 700 million preferred shares (6 percent dividend). He also secured the right to change his preferred shares to common shares of Bank of America at a fixed price of $7.14. Buffett exercised this option in 2017. If Buffett had had to buy the shares regularly on the stock exchange, it would have cost him around $16.5 billion. But in this way, he achieved a book profit of more than $10 billion.

Warren Buffet pursued a similar approach at Goldman Sachs before as well. In September 2008, Berkshire had bought 50,000 preferred shares of Goldman. As a first consequence, the bank had to pay annual dividends of over $500 million. Furthermore, when Goldman repurchased the shares in March 2011, the bank had to pay Berkshire an additional $500 million package as a premium.

Is it safe to invest during a recession?

The question of whether it is safe to invest during a crisis or a recession cannot be answered in general terms. However, there are a few things you should think about and which may decide whether to invest or not a little easier for you.

Disclaimer: there are always risks

A short note at the beginning: You must be aware that investing always involves risk. The reason for this is simple. There are no easy and safe returns. Goods that promise such opportunities are limited. Conversely, everyone surely wants a profit machine without risk for little money. And as with all things for which there is a high demand but a scarce supply, this has an adverse effect on the price, it rises.

Against this background, please always remember that there is neither the philosopher’s stone nor a shortcut to get rich. If someone tells you otherwise, be extremely suspicious. On the free market, chances always (really always) correlate with risk and there is no free lunch. Otherwise, our system would not work. The second point is: Please do not believe that anyone in this world wants to give you a gift. Nothing is free. This dogma is especially true when it comes to financial matters. In the end, you have to make the fundamental decisions for your wealth management on your own.

Therefore, read the following sections with a grain of salt. I am convinced of my investment approach, but we all act on our responsibility and must be aware of the risks and dangers of our actions.

The more a price has fallen, the lower the further risk of loss

Okay, first of all, I must get the headline straight. As far as it concerns the stock market, a stock that drops 50 percent can drop another 50 percent. And then it can fall another 50 percent. And always remember, a stock that loses 50 percent must grow 100 percent to return to its starting point. Strictly speaking, a stock can become completely worthless. Your broker will liquidate all the shares of this stock from your portfolio. You may receive a short message and possibly a tiny refund of the rest value. That is all. Thousands of € or $ have disappeared into thin air. That’s investing, baby!

And yet I say that the more a share price has already lost value, the lower the risk. How does this fit with the above disclaimer? Well, look at this graphic. I love it. I could print it out and hang it over my bed. It shows that after every crisis, no matter how bad it has been, the markets rise again at the end of the day.

Bull vs bear markets
Bull vs bear markets

But please remember that the recovery may take some time. During the Great Depression, the bear market lasted almost three years.

At some point, however, the markets have always bottomed out. Of course, nobody can predict this point. But with every crash, the markets come closer to that point. So, paradoxically, if you expect markets to rise in the long term, the risk will decrease if you invest now during a recession. Conversely, you can boost performance because, as I said, a 50 percent loss requires 100 percent growth to return to the starting point.

Capitalism and liberty are the engines of rising prices

In the end, you will have no choice but to believe in rising prices. Ever since humans have existed, they have striven for progress and development. There is hardly a more beautiful expression of this development than the famous match cut sequence in Stanley Kubrick’s film “2001: A Space Odyssey”:

Match Cut
The famous match cut sequence in Stanley Kubrick’s film “2001: A Space Odyssey”

Do you think that after all these thousand years, you will catch the very phase of humanity where this development stops? I think that’s highly unlikely. Regardless of how one views the negative consequences, liberty and capitalism have ensured that people always wanted to go further, to discover (or to create) problems, and to find new or better solutions.

There have always been and always will be mistakes, setbacks, and adverse developments. But in the end, the chances are good that humanity will make further progress. New markets, such as cloud computing, will emerge and enable extreme growth in many areas. Be an optimist and look to the future with confidence, especially in times of crisis.

A stock market crash makes something physically impossible possible 

Instead of embracing doom and gloom scenarios, my mood rises when I see my stocks losing value because now it is possible to travel back in time and get companies at a price I haven’t seen in years. And that’s a great opportunity – possibly life-changing. In the COVID-19 crash, I bought many excellent companies at a price I last saw in 2015 or 2016. Back at that time, I had much less capital on hand and was upset. The 2020 stock market crash gave me a second chance.

Stock market crash is like time traveling TEV Blog
Investing during a stock market crash is like time travel. But instead of traveling into the future, we do the impossible and travel into the past. Picture: Ferdinand Georg Waldmüller (1793 ‐ 1865) – The Expected

Where to put money in a recession?

So in this respect, there are good reasons for you to invest money even in a crisis or a recession. You can choose between several asset classes here. Many people swear by gold and real estate in particular. Other investors simply continue to invest in the stock market. Let us take a brief look at the performance of the respective asset classes.

Is gold a good investment in a recession

Gold is generally regarded as crisis-proof. And indeed, in times of recent major crises, gold has usually performed better than the average market. In the last year of the Great Depression, for example, gold even gained more than 40 percent in value.

Asset Classes Performance: Great Depression
Asset Classes Performance: Great Depression

In the period after the bursting of the dot-com bubble, gold has also outperformed the broader stock market.

Asset Classes Performance: Financial Crisis
Asset Classes Performance: Dot Com

The same applies to 2008, the year of the financial crisis.

Investing During Recession
Asset classes performance: financial crisis

First of all, this only means that those investors were happy who already had gold in their vaults at the time of the recession. Whether investors should also invest in gold during the recession is another question. To answer this question more accurately, I have looked at the years from 1995 to 2020. Above all, I did not look at the overall performance, but at the annual return that gold has brought compared to other asset classes. I then combined the individual results in a graph. The following picture emerged:

Investing During Recession: Performance Asset Classes 1995-2019
Investing during a recession: performance asset classes 1995-2019

You can see that the stock markets have performed particularly well in the years following significant slumps. So, while gold was less affected by downturns, the gains in value were also less. And if you look at the average annual returns, you can see that gold has also underperformed the stock market in the long run.

Investing During Recession
Investing during a recession: average annual return 1995-2019 by asset classes

Hence, anyone who pulls his assets out of equities and shifts them into gold just before a crisis would historically have a chance of achieving a better return. As so often, the theory is beautiful, but in practice, it often encounters hurdles.

The fact that a high profit is theoretically possible does not mean that it is realistic to achieve it. It is usually impossible to predict when the next recession will begin. There is also the danger that investors will sell their gold in a stock crash. This sell-out might be because they need new liquidity themselves or because they want to buy additional shares at low prices. Ultimately, you would primarily rely on market timing and, in the long run, invest in the lower-yielding asset class.

Real estate investing during a recession

Another option is to invest in real estate. Buying your property in a recession could be difficult as you usually have to raise a lot of capital for it. If you are sufficiently liquid, you probably have fewer problems in general. Otherwise, it is quite risky to take out a loan in bad economic times and get into debt like this. Accordingly, it could make sense to invest in stock-listed real estate companies. These could be normal companies or so-called REITs (Real Estate Investment Trusts).

You can see that the recent crises have provided good entry opportunities for investing in REITs. However, this performance is also related to the nature of a recession. The Great Recession in 2008 and 2009 has emerged from the subprime crisis. The crash of many REITs at the beginning of the COVID19 crisis was also since many businesses were forced to close and were thus no longer able or willing to pay their rents.

Correlation between Asset Classes from 1995-2019 Image
Investing during a recession: correlation between asset classes from 1995-2019

So if the last crises had not had a particular impact on real estate, perhaps the performance of REITs would have been even better. But even so, REITs have offered excellent investment opportunities. Compared to other assets, they have generated the highest average annual returns since 1995.

Annual Returns By Asset Classes 1995-2019
Investing during a recession: annual returns by asset classes 1995-2019

A comparison of asset class performance between 2001 and 2020

A look at the years from 2001 to 2020 also shows that REITs have performed very well. Even more striking, however, is how poorly individual investors invest.

On balance, the performance of investors has been disappointing. According to J.P. Morgan, the average investor gained just 2.9 percent per year in the mega bull markets from 2001 to 2020. Investing in an ETF would have been a far better decision.

The sad performance of private investors: 20-year annualized returns by asset class (2001-2020)
The sad performance of private investors: 20-year annualized returns by asset class (2001-2020), Source: J.P. Morgan

Investing in stocks

The charts above have probably already shown you that crises are excellent opportunities to invest in the stock market. Stocks allow you to invest in all industries and a considerable number of companies. You become the owner of a company and participate in its success (and failure). You can also invest indirectly in gold, for example, by buying shares in gold mine operators such as Barrick Gold. Accordingly, it is possible to diversify assets relatively widely with stocks alone. And as you’ve seen above, the broader equity market has delivered excellent performance over a more extended period.

Value investing in stocks during a recession

Investing in stocks during a recession is therefore one of the best ways to increase your assets over the long term. However, you should not blindly buy everything just because it has lost value in a recession. There are a few essential things you should be aware of before you jump in.

Not all at once

“Not all at once!” There’s so much meaning in that half sentence. So let’s go through it.

First of all, you should not invest all your capital. Always be liquid for emergencies. A good rule of thumb is to keep three to six net salaries of capital liquid. Otherwise, you may have to sell stocks that are close to the bottom. This means that you should only use capital that you will not need for the next ten years. If you invest during a recession, it is historically unlikely that if prices continue to fall, it will take 10 years for prices to return to your purchasing level, but you should still play it safe and not have to spend your invested money elsewhere for that period.

Secondly, I suggest not to invest all your available capital for investments at once. This advice is of more psychological value. From a purely historical and sober point of view, the best thing to do at a young age is to always take an “all-in” approach to the stock market.

So if you are extremely rational, then this is the most effective way. Psychologically, however, it might make sense to invest in several tranches. Especially when you invest in a crisis, things can go even further downhill. So you can use short-term price losses to buy certain stocks even cheaper.

You have to conduct a throughout due-diligence 

If you invest your hard-earned money in a company by buying stocks, you become co-owner of a company. Surely you want to know what you’re investing in, right? Unfortunately, I have often experienced that many investors think differently, especially at the beginning of their investment career.

Many people think very carefully about which new iPhone to buy, which laptop suits their needs, or which car to own. But when it comes to shares, they buy anything that promises a return. They simply follow any praise or advertising leaflet without looking closer or checking. Especially in recessions, the intrinsic value of a company should be closely examined.  In times of crisis, you should pay particular attention to the following characteristics of a company.

Earnings and cash flows are decisive for me

Since you want to invest in a company and this company has a specific price, you need to know what exactly you will get for this price. Is the company a bargain, or does someone want to sell you garbage for gold? You should be guided here by a quote from Warren Buffett, who once said: “Price is what you pay; value is what you get”.

Price is what you pay; value is what you get
Warren Buffett: investing during a recession – how investors build up wealth in times of crisis

So I look for value. But what is value? Well, my approach is straightforward. I look at figures that are most closely related to the reason why I invest in stocks.  I invest in stock and become an owner of a company, like a real entrepreneur. So I should better think like an entrepreneur.

From my point of view, a great entrepreneur must have only one goal: to create value in the long term. However, please note that this value does not lie in selling as many products as possible. That would be too easy. Just give me €/$ 1 million, and I’ll make €/$ 500,000 in sales. For me, investing is all about putting food on the table.

For this purpose, I look so much at a profit and positive cash flow which applies to a company like Amazon, but also to the woodworker or shoemaker around the corner. Therefore, relying on other metrics such as price-to-sales (P/S) or price-to-book (P/B) ratio to justify investments is extremely foolish.

Fair P/S ratio and fair P/B ratio TEV Blog
“Sorry honey, no dinner today”

Strong balance sheet

In addition to examining profits and cash flows, I look closely at the balance sheet of companies. Are they heavily indebted and have difficulties in continuing to operate profitably with their business? Can the companies survive another year or two with a weak economy? Companies with a high debt ratio are often not very creditworthy. In times of economic downturn, they have difficulty obtaining new loans from banks, or they only get loans with very bad conditions.

The debt ratio is a good financial metric that shows the percentage of a company’s assets that are provided through debt. A ratio above 60 percent is usually a warning sign. As soon as doubts arise here, keep your hands off such companies, even if a strong rebound is tempting.

Recession-resistant business model

It is good to invest in shares of companies that have a recession-proof business model. These so-called defensive companies are less dependent on economic developments and therefore less cyclical in their business. Look here for companies that produce everyday products or other important (non-cyclical) consumer goods. But also tech companies have become so important that they can fall under this category. Think, for example, of Microsoft with its many office products or cloud solutions, which are indispensable for the everyday life of many people and many companies. Companies with a recession-resilient business are for example:

Procter & Gamble

Colgate-Palmolive

Kimberly Clark

Reckitt Benckiser

Johnson & Johnson

Microsoft

Electric, gas, and water utilities

Less resilient and therefore more cyclical companies are, for example:

Ford

General Motors

Caterpillar

BASF

DowChemical

Financials

Sustainable dividends

Dividends can also indicate a company’s intrinsic value. The dividend yield is the ratio of the dividend payment per share to the share price. If a share costs $100, and the company pays $2 in dividends per share, the dividend yield is 2 percent. I love dividends as they provide a reliable monthly cash flow.

While high yields above 7 or 8 percent are not unusual for recessions, you must also be careful when considering dividend yields in isolation. High dividend yields are big red warning signs. The market gives you no presents, and with a high chance always comes high risk. Maybe, the cash flow or the profit does not cover future payouts, pushing the company to reduce or even cancel the payouts.

So look at the payout ratio. You should also look at whether the company has maintained or even increased dividends in the past during crises. Even if this does not guarantee that the dividend will not be reduced, it does show that the company has successfully mastered difficult phases and the management could have experience in this.

Know the risk profile of your investments

You should also pay attention to the risk profile of your investments in times of recession. It is irrelevant whether you want to invest in stocks or other asset classes because most asset classes offer a wide range of risk profiles. Basically, you should choose a risk profile with which you can sleep peacefully. The right profile depends on how high your risk aversion is.

It is best not to overweight your investments in high-risk areas. In times of crisis, you should, therefore, conduct thorough due diligence (see above), especially for small caps or riskier asset classes such as P2P loans with a high default rate.

Risk Allocation & Diversification Image
Investing During A Recession: Risk Allocation & Diversification Image

Invest in yourself!

In a crisis, don’t forget to invest in the most important asset of all and that is you (your human capital). Take the opportunity to increase your market value. A high market value alone can give you more freedom than some passive income. With high market value, you are already relatively independent. If you don’t like your job, you can just quit it (at the latest when the recession is over). You will find a new job and be welcomed with open arms. You do not have to be mistreated by anyone, neither by your colleagues nor by your boss.

Furthermore, don’t fall for the “the corporate world is bad” narrative. 60 percent of employees believe that their coworkers are the most significant contributor to their happiness at work and according to the Edelman Trust Barometer 2020, 37 percent of the 34,000 people surveyed ranked employees as an essential ingredient to a company’s long-term success. The corporate world is therefore a place where people are often valued. This gives them a lot of power and opportunities to develop and learn. So take advantage of the perks and employee programs and get value from them.

Investing during a recession: conclusion

Investing during a crisis or recession can give a huge boost to the value of your assets when the economy picks up again. However, you should do it right and focus on the risk profile of your investments. You should also not try market timing, but either go all-in immediately or take advantage of the cost-average effect.

I used the following sources for this article:

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