Even seasoned investors get nervous when the economy hits a slump. The economic impact of recessions may be relatively mild or severe, but the corresponding drop in stock values are usually precipitous and cause for major anxiety.
Recessions can be both harmful to your wealth and offer investing opportunities. Interest rates tend to decline as a result of the Federal Reserve’s monetary policy decisions, which are meant to boost economic activity. This can drive cheaper mortgages and potentially lower rates on debt. But that also means falling interest rates on bank deposits, which can leave savers getting less yield for what they sock away. Meanwhile, lower stock prices can hurt your portfolio — or offer deals when you buy shares.
There are key things to know about how to secure your investments during a recession, including alternatives to stocks with attractive rates — whether you might need to withdraw that money soon or you’re able to let it ride out a recession.
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How to Keep Money Safe In a Recession
Cash is king, and that’s more true than ever during a recession. Keeping more of your net worth in cash is a great way to stay safe in a recession. The liquidity of cash makes it a reliable fallback when the value of non-cash investments like stocks are taking a dive. If you face a financial emergency, you can access your money without worrying about the cost of out of an investment that’s heavily devalued against what you originally put in.
But falling back on cash shouldn’t be your only strategy for keeping your money safe in a recession. If you’re sitting on funds in your checking account, you’re very likely losing out on potential earnings on that side of your portfolio. Interest rates on low-risk investments including CDs, bonds and high-yield savings accounts have increased in recent years. They make particular sense for those who want their money to remain more or less liquid, yet grow at a decent pace, even during a downturn that makes selling stocks a bad idea.
What Happens to the Economy During a Recession
Recessions, like expansions, are a regular feature of economic life. They’re thought to be the result of a lack of aggregate demand, including consumer spending and business activity. However they exactly happen, the effects are mostly predictable in nature. GDP and stock markets drop, inflation recedes.
The Federal Reserve generally responds to recessions by easing interest rates, in hopes of boosting consumer spending and making loans cheaper for things like homes and cars. The idea is to pump investment back into the economy.
Of course, Fed efforts to reduce rates also causes banks to lower the interest rates that they offer on deposits. In other words, you could be getting less yield for what you save. How quickly all of these pieces fall into place, however, is hard to predict — much like the exact onset of a recession.
What Should You Invest in During a Recession
If a recession appears to be imminent and you have a high balance in your checking account, it’s time to think about securing a better return on your money before interest rates start declining sharply. While a high-yield savings account is one sensible approach, the particular dynamics may make it so that you’ll do better pursuing a certificate of deposit (CD).
First of all, CDs may offer higher yields than savings accounts. CD rates have recovered more recently from their post-financial crisis lows and currently look good, exceeding the annual rate of US inflation. Online-only banks in particular are offering rates that beat competitors.
During a recession, CDs offer a great safe haven for your money because they have fixed rates — a special advantage amid the economic turbulence of a recession. The guaranteed rate ensures the earnings outcome. You know how much you’ll always be getting, and you don’t have to worry that the growth in your funds will evaporate as interest rates fall.
Naturally, there are downside risks as well. CDs work on a clock: Issued in terms from one month to 20 years, their fixed terms mean your money is locked in for the length of time you have agreed to. You won’t be able to withdraw funds as you would from a savings account. While you may be able to get the cash before scheduled, you will face costly penalties for early withdrawals.
One way to combat this reality is through what’s known as the CD ladder, a strategy involving the utilization of various CDs of different terms, allowing you more freedom in the flow of your cash and the ability to maneuver along with the waves of the market. Recessions don’t stick around forever, so being flexible helps. If you’re uncertain of which way the winds are headed, both in the economy and in your own financial portfolio, gradually adopting and carefully selecting these products could bring remarkable benefits.
The particular CD account in question should also be carefully scrutinized. Interest rates on your investments go up the longer you’re willing to sign up for time kept in the bank. A one-month agreement could get you a 0.11% rate of return, while three years could bring you 0.93%, a hefty difference.
A recession, at least given historical precedent, is not worthy of panic. But it does require savvy moves to make sure you’re chugging along. Keeping in mind realistic goals for how you’ll use your investments will help you figure out the right target. A diversified portfolio is of course always recommended, but what that means depends on the scenario, and CDs among other products can be a fortuitous answer.