Study On How To Invest During Recession Finance Essay - Free Essay Example

Sample details Pages: 7 Words: 2188 Downloads: 9 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? In economics, a recession is a business cycle contraction, a general slowdown in economic activity over a period of time. During recessions, many macroeconomic indicators vary in a similar way. Production as measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization, household incomes, business profits and inflation all fall during recessions; while bankruptcies and the unemployment rate rise. The key to investing during a recession is therefore to start off with the right mentality and do not panic. Recessions can be scary, but they also lay the groundwork for opportunities in the future. Interest rates fall and it becomes less expensive to borrow money. Cost-cutting processes can teach a company to become more innovative and competitive. The lower demand for products and services brings down the effects of inflation. Stock market timing is not exact, but chances are that if you invest during a recession, once the market has r ecovered you will benefit from the increase in price that your investment will bring by way of profit when you do decide to sell. Blue chip stocks are these companies hold leading positions in their industry and have a long, unbroken record of earnings growth and dividend payments. These stocks are high-grade, investment-quality issues of major companies that have the fundamental strength and size to hold their own during a recession and enough resources to capitalize on an economic recovery. All in all, investors who are conservative and who seek safety and stability will usually invest in this group. Examples of blue chip stocks in US stock market include IBM, Intel Corporation, Coca Cola, Bank of American, JP-Morgan Chase, Microsoft Corporation, Walt Disney Company, American Telephone Telegraph, Wal-Mark Stores, General Electric Company, and others. Otherwise, investors typically add defensive stocks to their portfolios during economic recessions, or market downturns. That s because defensive stocks can be expected to perform relatively well during all phases of a business cycle even during difficult economic conditions. A defensive stock is normally associated with a company that belongs to an industry or market sector that is unaffected by business cycles. That is to say, consumer demand for their products or services exists no matter how good or how bad the economy is performing. Defensive stocks are the opposite of cyclical stocks whereby the financial health of cyclical companies move in-sync with the health of the economy. Thats why these stocks are also referred to as non-cyclical stocks. Defensive stocks include companies belonging to the following market sectors are utilities, food beverages, healthcare, non-durable goods. There include American Telephone Telegraph (Telecommunication), Coca-cola Company (Beverages), Johnson Johnson (Pharmaceuticals), Procter Gamble (Consumer goods) and others. The biggest advantage an investor gains throu gh the purchase of defensive stock is a conservative portfolio that should provide above average returns during a recession. The profitability of these stocks will hold up during these hard times because the demand for the products or services of these companies is relatively inelastic. Investments in utility stocks are stocks of electric, water, gas, and telephone companies that are usually with a relatively decent dividend income and high degree of safety. Whether the economy is growing or slowing, people just need electricity, water, gas and phones, these services are an indispensable part of our lives. There include Exelon Corporation, Southern Company, Dominion Resources Industry and American Telephone Telegraph and others. Gold is traditionally seen as a safe investment, especially during a time of financial uncertainty, high inflation, depreciating exchange rates and economic recession. During a recession, gold is seen as a better investment than say the stock market. Sto cks will fall as companies make less profit. Gold is seen as a safe investment for preserving value of assets. This encourages speculative buying of gold as investors diversify out of other riskier investments. Gold has an intrinsic value. A currency like the dollar or Pound Sterling can depreciate in value and the value of the dollar depends on the strength and stability of the US economy. For example, hyperinflation can wipe away the value of your savings e.g. Germany 1923 and Zimbabwe 2008. During this kind of crisis Gold makes a very good investment. Gold will also become attractive if we have negative real interest rates e.g. inflation higher than nominal interest rates. With negative real interest rates, saving in a bank becomes less attractive and gold become more attractive. Gold did well in Great Depression and Second World War which both crisis of different sorts. During a recession, interest rates are typically at their lowest. This means that it will cost the average person less money in terms of interest payments to make large purchases. Among the largest of purchases is the purchase of a home of piece of investment real estate. As the demand for homes tends to decrease during a recession, sellers are forced to lower their asking prices in order to be more appealing to buyers. This lower asking price is also a monetary advantage to the individual looking to invest in a home or to buy a home and hold on to it long enough to have the market rebound and then sell that home for an easy profit. New home sales have seen a steady decline in value during the recession, but that is by no means the only indicator that those looking for an investment opportunity should use to base their decisions off of. Buying a new home that is currently undervalues simply because of the status of the market can be a brilliant investment move. But just as is the case during times where we are not in a recession, certain homes and pieces of property hold their value much better than others. Careful consideration and wise decision making is always something you want to be sure that you remember. Corporate bond is a type of bond issued by a corporation. Corporate bonds often pay higher rates than government or municipal bonds, because they tend to be riskier. The bond holder receives interest payments (yield) and the principal is repaid on a fixed maturity date. US Treasury bond is a negotiable, coupon-bearing debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of more than 7 years. Interest is paid semi-annually at fixed coupon rate. U.S. Treasury Bonds are exempt from state and local taxes. These securities have the longest maturity of any bond issued by the U.S. Treasury, from 10 to 30 years. The 30-year bond is also called the long bond. These bonds are not callable, but some older U.S. Treasury Bonds available on the secondary market are callable within five years of the maturity date. The prices of the long term US Treasury Bonds or the highest investment grade bonds would expect to increase during a recession because interest rates tend to fall during a recession. Corporate bonds for a bit more risk and pay out higher amounts but have just a little bit more risk than treasury bonds, especially during a recession. Bonds are considered to be less risky than stocks, since the company has to pay off all its debts (including bonds) before it handles its obligations to stockholders. Corporate bonds have a wide range of ratings and yields because the financial health of the issuers can vary widely. A high-quality Blue Chip company might have bonds carrying an investment-grade rating such as AA (with a low yield but a lower risk of default); while a start up company might have bonds carrying a junk bond rating with a high yield but a higher risk of default. Corporate bonds are traded on major exchanges and are taxable. A high yield bond (non-investment grade bond, specul ative grade bond or junk bond) is a bond that is rated below investment grade at the time of purchase. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors. Therefore, investors with a greater risk tolerance and much deeper pockets may even want to consider buying into a junk-bond fund. Recent history has shown that junk-bond investors have earned their best returns the year after the junk-bond market bottoms out. In 1991, while the nation was mired in its last recession, the junk-bond market produced an eye-popping 34.6% return on investment, according to Moodys. The impact of declining interest rates is magnified on the junk-bond market because high-yield bonds carry much higher rates than other kinds of bonds. Declining rates make those high yields that much more attractive, which tends to raise the price of the bonds that pay them. An exchange-traded fu nd (or ETF) is an investment vehicle traded on stock exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the SP 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features. Investors can buying shares in several exchange-traded funds, or ETFs à ¢ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ stocks that track the performance of a major market index such as the Dow Jones Industrial Average or the Nasdaq 100, or are based on actively managed mutual funds. That way, they can participate in any early rally in stocks without being overly exposed to any single companys poor earnings performance. ETFs have grown in popularity with individual investors because theyre cheaper and easier to invest in than traditional stock index funds during recession. Money ma rket deposit account is a savings account which shares some of the characteristics of a money market fund. Like other savings accounts, money market deposit accounts are insured by the Federal government. Money market deposit accounts offer many of the same services as checking accounts although transactions may be somewhat more limited. These accounts are usually managed by banks or brokerages, and can be a convenient place to store money that is to be used for upcoming investments or has been received from the sale of recent investments. They are very safe and highly liquid investments, but offer a lower interest rate than most other investments. Credit default swap is a specific kind of counterparty agreement which allows the transfer of third party credit risk from one party to the other. One party in the swap is a lender and faces credit risk from a third party and the counterparty in the credit default swap agrees to insure this risk in exchange of regular periodic payments es sentially an insurance premium. If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. In turn, the insurer pays the insured the remaining interest on the debt, as well as the principal. During recession, investors should keep some extra money in an interest-bearing money-market account especially if theyre investing money theyll need fairly soon. Investors shouldnt expect to get rich off the 4% annual yields offered on most money-market accounts but at least theyre guaranteed to make some money. Investors also stash some money in six-month or one-year bank certificates of deposit which on average pay a 2% higher annual yield than a money-market account. For the casual investor who does not have the time or inclination to actively manage his or her own portfolio, mutual funds reduce the time and effort needed. That stays true even in a recession. The trick is finding mutual funds that do well in tough economic times. There are certain industries that weather recession better than others and the best mutual funds will be sector funds which are based on a specific industry. Industries that do well during economic downturn include utilities and staple consumer goods. Mutual funds in recession-proof sectors can still be volatile and under-perform if the fund manager buys and sells constantly or the fund charges a high management fee. Review the fee structures for the funds you are considering and choose one with a high historical return and low fee. Other mutual funds that can be considered as recession proof would include money market funds and bond funds. The best way to use mutual funds both before and after a recession is to have a diversified mutual fund portfolio in the first place. Having a constructed portfolio of both stocks and bonds will provide you an opportunity or cushion for participating in stock market growth or markets decline. Conclusion, recession may not seem like the best time to be investing your money but just because we are in a recession doesnà ¢ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒâ€šÃ‚ ¢t mean the market has come to a complete standstill. There are different ways you can invest which obviously vary depending on your current financial situation, but yes, there is an investment possibility for everyone, which can help put a little extra savings back in your pocket and even yield some future wealth down the road. Practicing a bit of patience and proper financial planning can go a long way in these times of economic turbulence. Don’t waste time! 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