Recessions and Stocks

by Gary Foreman


Gary,
Are we headed toward another recession? I am in stock mutual funds and wonder if it is time to go into a money market for safety.
SC

The correct answer to SC's question is: I don't know and I don't care. No, I'm not being sarcastic. In fact, trying to answer this question could harm SC's wealth.

Here's why. No one can know for sure what the future will bring. A recession is defined as two consecutive quarters where production declines. A lot of highly trained economists and forecasters are making various predictions about the future. Some of them will be right. And others won't.

It's not that the experts are stupid. It's just a very hard question to answer. A huge number of things affect the economy. Government policy, people's job security. And some things, like natural disasters, that no one can predict.

Besides that, it's really not a yes or no question. There's very little practical difference between the economy growing or shrinking by 1/10th of 1%. Yet, that's the difference between being 'in a recession' or not.

OK, so let's agree that we can't know for sure whether a recession is starting. The good news is that we don't need to forecast the economy to invest successfully. In fact, trying to predict the future could actually lead us to a lower return on our investments. There's a couple of reasons that's true.

SC's question assumed that an upcoming recession would be a time to sell stocks and move into a mutual fund. That's not necessarily true.

In fact, a recession could be a good time to buy stocks. There's an old Wall Street proverb that advises that you "buy on bad news and sell on good news". The reason is simple. People buy and sell stocks based on what they think is going to happen in the future. When most people are thinking about a recession stock prices have already been adjusted for it. So, to put it bluntly, it's too late.

There's another danger for SC to consider. Trying to guess the direction of the stock market is tricky business. To do it successfully you need to buy and sell before other people do. And the people that you're competing with are well paid, highly trained professionals. They work for the big Wall Street firms. Their full-time job is to guess where the market will go and move the billions of dollars that they manage to get there first.

That's some stiff competition. And unless SC is particularly skillful or just plain lucky, the big guys are almost bound to win. So it's probably foolish to try to play that game.

But, there's more good news. You don't have to play to make money in stocks. Two simple strategies can make anyone a winner in the stock market.

The first strategy is to buy with the long term in mind. Invest with an eye to winning over a 5, 10 or 20-year time frame. The reason is simple. Although the stock market is unpredictable in any one year, it's much more predictable over 5 years. And very safe if you invest for 10 years. The past proves it.

The historical return has been about 10% per year when you measure groups of 10 consecutive years. Going back to the great depression there's no case where you would you have lost money if you invested for 10 years or more.

Although not a part of the question, the second strategy that SC should implement is the practice of investing on a regular basis. Even if it's only a few dollars each month. During the years that stock prices fall SC will be buying at bargain prices. The surest way to get those bargains is to invest some money on a steady basis.

So what should SC do? In part it depends on what they want to achieve. If safety is an issue then SC shouldn't be in stocks at all. They'd be wise to sell now and put the money into something stable like a money fund. That would be true no matter where the economy was going. Stocks are no place for your 'safe money'.

On the other hand, if SC is saving for the future then they should forget about the economy. They can rest comfortably knowing that time is on their side.

One final comment about stock investments. As complicated as the markets are today SC is wise to have chosen to use a mutual fund. Owning individual stocks adds risk to your investments. It's much harder for a company to do well for ten years than it is for a managed mutual fund.

Thanks to SC for asking an interesting question.


Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.

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