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Beginning with the Great Depression, the U.S. economy has experienced 14 major recessions, including the current one that began sometime between December 2007 and January 2008. The average length of past recessions has been 13 months. Given that we're already into month 16 of this recession, it's time to start looking at financial markets opportunistically.
For this month's Wealth IQ Report, we first examine how stock markets have behaved in past recessions. Then we calculate hypothetical returns, assuming we had invested during two past recessions.
Recessions Often Lead to Opportunities
Does Dollar Cost Averaging During a Recession Work?
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Darren Whissen
Recessions Often Lead To Opportunities
The stock market is forward-looking - it moves in anticipation of expected events. For example, if the Federal Reserve as expected to raise interest rates, the market typically would have priced this in even before the rate hike actually happened. Likewise, past market recoveries have typically started before a recession was officially over. Thus, if you wait until the end of the current recession before you invest, you may miss a very attractive investment opportunity.
The charts below show the S&P 500 Index's movement shortly before, during, and after each of the seven U.S. recessions over the past 50 years. During this period, recessions lasted an average of 12 months, and stocks hit bottom an average of 4 months before the recession ended. Of course, past performance cannot guarantee future results.
The unmanaged S&P 500 index represents the general stock market and is for illustrative purposes only. One cannot invest directly in and index. While stocks have historically outperformed other asset classes over the long term, they tend to fluctuate dramatically over the short term. Investors should be comfortable with fluctuation in the value of their investment.
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Does Dollar Cost Averaging During a Recession Work?
With the U.S. economy currently in its 16th month of a recession and market conditions uncertain, many investors may be inclined to stay on the sidelines while they look for more positive news. However, past economic downturns have created significant opportunities for investors who periodically stepped into investments during periods of market volatility.
Dollar Cost Averaging (DCA) - the practice of investing a fixed dollar amount at regular intervals (such as monthly) in a particular investment or portfolio, regardless of its share price - can help investors earn a positive rate of return over time, even in a recession or down market.
The basic principal behind DCA is by buying at regular intervals, you potentially lower your average cost per share purchased. By beginning a DCA strategy when the market is down severely, you could be buying shares at a good value and be better positioned to benefit from future rebounds in the equity market.
To help explain this point, let's look at two of the most memorable recession in history and see what would have happened if we:
Began a 12-month DCA strategy mid-recession;
Invested a lump-sum investment mid-recession; or
Stayed in cash until the recession ended and then made a lump-sum investment.
In each case, we start with $250,000 to invest and track the results over a five-year period.
As these examples illustrate, the investor who started a DCA strategy to gradually invest in the equity market - even in the middle of the worst recession in history - would have achieved significantly better long-term returns than the investor who waited out the recession in cash and only invested when it was over.
It's important to remember, though, that dollar cost averaging cannot guarantee a profit or protect against loss in a declining market. You should consider your ability to continue to invest during periods of market volatility.
As always, your questions and comments are appreciated.
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Disclosures
A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The value of an investment in debt securities will change as interest rates fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. Investments in high-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income.
The opinions in the preceding commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole.
This material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict performance of any investment. Investing involves risk, including possible loss of principal. Investors should consult with a financial advisor prior to making an investment decision.
Diversification does not guarantee a profit or protect against loss in a declining market.
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