Investment risks during tough economic times: Feature Article
Anyone who pays attention probably knows that the economy is headed South, and conventional wisdom has it that when the economy goes bad, you pull in your horns, tighten your belt, cut down expenses, and save. However, sometimes investing can have a real advantage, especially if stocks are low and you do not plan to cash them in for several years. However, investing is never cut and dry, and there are all sorts of ways to invest. The following is a look at some of the risks of investing during tough economic times, and how to avoid risks as best as possible.
Economic risks are always a factor when it comes to investing. If the economy goes bad, your investments lose value, and t can take years for that value to return. This was seen first hand after 9/11. However, for young investors, this time can be looked at as an opportunity. If you already have investments, the best strategy for avoiding losses is often to just hunker down and ride out these downturns. If you do not sell your stocks, or pull out of whatever investments you are in, you won't actually lose. So, stick with them until they go up again. If you have not yet invested, and are considering it, then investing during tough economic times can really benefit you. If you can do your homework, and invest in good solid companies, these down times for the economy are often good times to do so because it costs less for you to get in, and you can ride out the storm.
If you are really worried about the US economy, and do not want to invest in it, you can always look into foreign stocks. If your domestic market is in the dumps, and you do your homework right, then globalizing your investments can result in big profits. However, it is important to recognize that often economic downturn in one market leads to the same in others.
Now, if you are not a young investor, then the economy going bad is one of the biggest risks you take. For example, let's say you invested in order to have money for retirement. If your retirement is near when a major downturn in stocks occurs, it can be devastating to your retirement fund. So, if you are worried about the economy going down, and you do not want to risk your retirement money, then don't start investing during economic hardship, and do your best to shift your assets to bonds or fixed income securities. Most experts agree that the biggest risk for investors during tough economic times is the major losses that come if you have to cash in while stocks are in a slump. If you can ride it out, and do not need the money for 10 plus years, it usually won't hurt as bad, as long as the companies you are invested in do not go under.
When the economy is poor, and stocks fall, it is often referred to as a bear market, and experts agree that the key to making it through a bear market without losing sleep comes from the construction of your portfolio. If you diversify right, and set yourself up for the right risk amount, you will be able to ride out an economic storm without taking too big of a hit. For example, if you are investing as your 401(k) or 529 (and education fund for your children) you would probably want to invest in a mix of a number of mutual funds, ETFs, stocks, and bonds. That way if the economy does turn sour, you aren't completely without funds for retirement or education.
Evaluate your risk tolerance, and your ability to just not look at your portfolio during tough times. If you are going to give yourself a heart attack looking at potential losses every day, investing in less risky, and less rewarding things is better for you. If you have a few decades before needing the money, and are an aggressive investor, you might be invested completely in stocks. Then as your need gets closer you may shift to mutual funds and bonds, etc. There is nothing wrong with that, but you should only be invested this way if you understand, and are comfortable with the fact that you will see significant losses if the economy goes bad, and significant gains if it picks itself back up. That is the nature of investing. If you can't avoid the temptation to alter your investments based on what the prevailing markets are doing, you won't be very successful investing.
Even when the economy is bad, it is important to try and plan for your retirement, if you are worried about losing money then take advantage of dollar cost averaging. What is that? Dollar cost averaging is a technique best used for employer-sponsored retirement plans. Basically the way it works is you invest the same dollar amount out of every paycheck. Since you invest with each check, sometimes you buy when prices are high, and sometimes you buy when prices are low. As long as you do not pull your money out too soon, it all evens out in the end. When the economy goes bad, and investment values drop, your money goes further, but your previous investments are valued at less. However, if you continue investing, and don't panic and sell, in the end you will come out ahead. The risk comes when you have to get your money out sooner.
Because economic downturn seems inevitable right now, you may want to invest in ETFs or mutual funds. These are designed to go up when the market goes down. The risk is that they go down when the market goes up, so, they are a good way to offset losses elsewhere in your portfolio, but for long term needs, they are not the best. If you aren't careful you could hurt yourself more than help yourself with investments. You can't time the market, and should not try, but if you want to reduce your risk of loss, having some as a part of your portfolio can mean on average you are doing well.
The kind of stocks you invest in during a tough economic time will affect your risk level. For example, start ups are usually not going to make it if the economy goes bad, but some stocks will weather the storm. You may want to consider investing in defensive stocks. These are larger companies better suited to withstand a prolonger bear market, which is what you get when the economy goes bad. So, when investing during a poor economy, or to avoid risk in a poor economy, look for companies with strong balance sheets, a long history of business, and more financial stability. While your returns will inevitably not be as high, you can minimize the impact of a declining market if you're concentrated on larger and more stable companies. So, it is give and take.
If you are worried about inflation, which often creates recessions and economic downturns, you can concentrate on investing in things called "hard assets" like real estate or jewels or precious metals. These are more value oriented, and withstand inflation better because they are physical assets. Of course, if you want to protect yourself against inflation, then invest in stocks. This won't protect you against recession, but stocks can adjust prices to the rate of inflation.
One thing people need to be careful about during tough economic times, is that they do not confuse an overall decline as a market value risk opportunity. Market value risk refers to what happens when the market turns against or ignores your investment, providing you with an opportunity to load up on good stock while the market is ignoring them. The problem is, if the whole market is flat lining, it may not be the right time to stock up, it might be a sign that the economy is struggling. So, be careful to distinguish what is something being forgotten and will be hot again soon, and what is being ignored simply because the economy is going south. To protect yourself better, invest in many sectors of the market, that way you will better be able to participate in any growth that does occur.
When economic times get tough, people tend to save rather than invest, and this leads to declines in the stock market, so instead of panicking and selling, try to wait and ride it out. At some point, the recession will stop, and hopefully the economy bounces back. If you have time, investment risks are far less during tough economic times. If you do not have time, then invest in things like mutual funds which provide less return, but are subject to less risk as well.