- Take Advantage of Declining Share Prices Using Dollar Cost Average
It is unlikely that you will know when the next recession is going to come. It happens with most recessions. One thing that is likely to happen is a decline in the stock market before the recession hits. This is when you need to remember that recovery is looming once the recession ends.
Once you know that as an investor, you should take advantage of a declining stock market through dollar cost averaging and navigating stock market turbulence. If you do not know what it is but you are regularly contributing to a qualified retirement plan, this is what you have been doing.
You need to take it a step further as when the market declines, you need to increase your contributions or start buying stocks in a non qualified account.
With dollar cost averaging, you will be able to bring down the overall cost of share price which means once the prices start to go up, your cost will be lesser than the initial price. Take a look at these steps to investing.
Let’s consider an example.
Consider investing in a mutual fund for $600 a month with the current price at $30 which should buy you 20 shares. If the price goes down to $20, you will get 30 shares. Now you have a total of 50 shares with an average cost of $24.
As the share price keeps going down, your original contribution of $600 a month will help you buy a greater number of shares while the cost continues to go down. Once the share price recovers, your $600 contribution will let you buy fewer shares but that share price is always going to be higher than your overall cost.
This investing method is the best way for long-term investors who do not want to worry about short-term impact of prices on their investments.
- Dividends
If you want to hold on to some stocks during a recession, you should identify companies that are established and have a large capital base along with excellent cash flows and balance sheets. These companies with a strong balance sheet are in a much better position during an economic downturn as compared to companies without strong cash flows. Also, stronger companies are more likely to pay out dividends.
Dividends offer a few advantages. If the company has been paying increasing dividends for a long period of time, you can rest assured that it has sound financials and would be able to survive a dire economic environment. The other advantage is that you get a return cushion. You will be able to generate a return on your investment even when the share prices are declining. This is the reason that dividend stocks always perform better as compared to non-dividend stocks when the market goes down.
The best way to acquire these stocks is through exchange traded funds or mutual funds that invest only in dividend paying stocks. Mutual funds that invest in stocks with an extensive history of dividends and a strong track record of consistent increases in dividends are able to provide better yield along with an appreciation in the capital.
Having said that, you should know that such funds do not outperform once the market rebounds. Investors keep these in their portfolios to generate stable returns without worrying about market cycles. Once the market has recovered, you can shift your allocations to other funds but it is recommended to keep a part of your portfolio invested in these funds as a defensive strategy.
You should know a few terms such as the adjusted closing price or dividend adjusted close. This is the price that is derived after adjusting for the corporate actions or distributions that happen during the closing of previous day and opening of the next day. Stock prices go down after payment of dividend as profit is distributed to shareholders and not reinvested into the company.
- Consumer Staples Are a Good Investment
Whether the market is growing or in recession, people are always going to need medical supplies, hygiene products, drugs and food. These are known as consumer staples which means these are unlikely to be cut off from the family budget.
It also means that companies that sell discretionary products such as flatscreen TVs will have a drop in revenue but companies that sell basic necessities and food products will not experience any such decline. It is due to this reason that companies that sell consumer staples are also known as defensive stocks as such companies remain resilient during a recession.
Data suggests that these are the companies that have outperformed the S&P 500 during the last 5 recessions. Some examples of these companies include Walmart, Procter & Gamble, Johnson & Johnson, and ConAgra. These companies are also known for paying good dividends which further makes them a good defensive stock.
There are mutual funds that invest only in such companies. One such example is the Fidelity Select Consumer Staples Portfolio where at least 80% of the assets are invested only in companies that engage in the sale, manufacture, or distribution of consumer staples.
