How to Invest During a Downturn in the US Economy?

Downturns, recessions, stock market crashes - all words that terrify the average investor. However, if you are prepared for a downturn in the US economy it is entirely possible to survive and even flourish if you are willing to take the time to understand the situation.

Investing isn't easy by any means, and even the most seasoned professionals will admit they learn new tricks of the trade every day. So now that the potential intimidation factors are minimized, lets explain a few ways to deal with the possibility of a US economy downturn.

Investors who have little knowledge of the stock market typically pick a mutual fund. This way, a professional investment manager and a research team invest your money as you see fit (for a small fee). However, with the advent of “sector funds,” many investors are heavily invested in one or two sectors (say technology and financial institutions) instead of maintaining a fully diversified portfolio.

Diversification is important because it spreads your money over a wide range of different stocks that may weather the storm while others lose half of their value. Some will argue that it no one ever got rich from a diversified portfolio, which is a valid point, but for the average investor who wants nothing to do with their portfolio but make double what a savings account offers, diversification offers the easiest method. Aside from being fully invested in cash or fixed income assets like bonds or CDs (which is not advisable).

If you choose to pursue this technique, an easy method is to buy mutual funds that hold the major indexes in their portfolios. Meaning, they own portions of the Dow 30, NASDAQ, or S&P 500. Alternatively, you can purchase individual Exchange Traded Funds (ETFs) which trade exactly like a stock and often have a lower expense ratio.

Again, the method in which you invest your funds should be based on your knowledge of financial planning and stock market trends.

Wall Street has done its homework in the last 10 years when it comes to different investment tools for the average investor. Once difficult investments to make are now just as easy as pushing a few buttons or calling up your broker and asking to buy a few shares of General Electric. In particular, are the methods of investing in foreign markets.

In my opinion, everyone should have some exposure to foreign investments thanks in part to the old adage “don't keep all your eggs in one basket.” Several countries have exploded on the global economic stage in the last several years surpassing even the most optimistic of analysts. Thus, its a wise idea to at least have some small exposure to this growth of capital. All that is required is logging into your local brokerage account and purchasing several foreign investment mutual funds that are located here in the US.

These funds can be sector or country specific just like US based stocks, and purchased just as easily. Some will focus on one country or a continent, like a “Pacific Rim” mutual fund as specific as a “Global Telecom” mutual fund that buys the telecommunications stocks of all the worlds major markets.

Portfolio rebalancing or dollar cost averaging is also a tactic that is used everyday by the best financial planners. In a economic downturn, the stock market presents an opportunity to buy great companies “on sale” compared to a normal or bullish economy. Therefore, its analogous to an after Christmas inventory sale where everything is 10% to 25% off retail price.

Most investors use dollar cost averaging without knowing it. For example, when you invest in a 401k program, each pay period a certain amount of your paycheck is deducted and used to purchase a mutual fund. Each transaction occurs at a different purchase price. Thus, over a 40 year time period the times you bought stock at a high price are offset by the purchases at low prices.

Another interesting, but more labor intense method, is to focus on investing in companies whose business is influenced by foreign economies. Meaning, there are many US based companies that obtain substantial amounts of business from foreign companies/governments by providing a service or product that is in high demand. A few examples are companies who are experts in engineering or oil discovery that seek long term employment contracts.

Lastly, many foreign companies allow their own stock to trade within the US markets just like any other US based company. Thus, providing the US investors with a very simple way to buy an oil company from China, a drug company from Germany, or telecommunications company in Russia.

No one likes to be told to “keep away” or "don't do this", but with investing one has to remember this concerns your financial future. Therefore, if you have little or just average experience levels its suggested that you do not attempt these methods without consulting an expert or financial advisor.

A recession presents an interesting opportunity for those on Wall Street known as Speculators or Traders. These individuals (including me), capitalize on the markets volatility in either direction. The well known method of “buy low, sell high” is the traditional method sought by investors. However, traders also make profits by “selling high, and buying low” through a technique called short selling. Some consider this practice in a negative view, but in some ways it is healthy to prevent the stock market from becoming overvalued similar to the stock market crash of 2000 – 2002.

If you have to really want to go nuclear and must make your 25% yearly returns, there are mutual funds who specialize in short selling however these are very speculative funds with high expense ratios. Its really not for the faint of heart.

If you're the average investor, just keep it simple. Markets go through downturns and upturns all the time but these days we have far too many reporters and newspapers telling us that the sky is falling. Learn to tune it out.

Diversify your portfolio with a few good mutual funds (I prefer Vanguard's family funds) from the US and a combination of other foreign markets.

If you prefer stocks, stick to names that you trust and research them thoroughly. Individual stocks are more volatile than a mutual fund or index fund, so expect to see your portfolio value fluctuate on a day to day basis.

Do not be afraid of asking for advice. Consult a professional or a trusted friend who is knowledgeable in these areas, or post a comment and I will direct you where to seek more information. I might even give you a few stock picks too.

Good luck!