Over the last 18 months, I have heard more, read more, and been asked more about recession than any other financial topic. Many people were scarred by the great recession of 2008, and fear similar suffering may be coming. I understand the concern, but is this recession obsession helping investors reach their financial goals, or is it inadvertently hurting portfolio returns?
Misbehavior motivated by fear of downturn is far more costly than the downturns themselves, and that includes the great recession of 2008. When it comes to investing, we are truly our own worst enemy.
The economy cycles through phases of growth, peak, recession, and trough. Then it repeats. On average, a recession comes every 5.6 years and lasts 11 months.
Too much of a good thing?
Economic positives often turn into financial imbalances that are so excessive they need to be corrected (tech stocks in 2000, housing in 2008). When balance is restored, business and people should get back to normal and economic growth will turn positive again. This makes recessions, in hindsight, like relatively small speed bumps on the economic highway.
When is our fear of recession damaging?
The recession obsession can cause investors to try to avoid losses by sitting on the sidelines. Nobody knows when the market will drop or how far it will fall. Likewise, the upward bounces catch those sitting out by surprise. That’s why the best days in the market typically follow large pullbacks.
Since 1980, investors that stayed in the market 99.9 percent of the time and missed only the best five days would have missed out on a massive 35 percent! Increase the best days missed to just ten, and returns are cut in half!
What about the best days? Since 1998, six of the ten best days occurred within two weeks of the ten worst days. Thinking you can get one while avoiding the other is not reasonable.
As we enter the 11th year of the current economic expansion, it is helpful to know that some of the strongest market increases have occurred during the late stages of the cycle.
Those who avoid the market under the pretense of protection inadvertently keep themselves from receiving that potential growth. Investors who stay fully invested through entire cycles, including recessions, experience greater growth.
The best advice I can give, for your portfolio and your sanity, is to create a financial plan that works for you. Stick to that plan and don’t worry too much about economic cycles. The financial plans we create for clients account for pullbacks, downturns, and recessions. Although every year in the market won’t be positive, your long-term outlook will be.
(Secret recession tip: After the stock market has dropped significantly, it’s usually better to buy than to sell; think of it as a long-term buying opportunity.)