Evaluating the risks and opportunities of a battered stock market
Stock market crashes are scary. Even if you’re a longtime student of personal finance and objectively understand that bear markets are healthy, every massive drop feels like an unusual circumstance that could be different and more crippling than all the previous ones — and someday that may actually be true.
As many non-essential businesses are temporarily (or permanently) closed, with their respective owners and employees out of work, obviously, the priority for those most directly affected is to simply tread water by whatever means possible.
However, if you are among the lucky few to still have a steady income with a surplus cash flow during a sharp financial downturn, you have a few options which you should consider according to your specific situation. None of these options are mutually exclusive, but you will likely find yourself leaning heavily in one area more than the others.
Option 1) “Buy the dip”
Early in the Coronavirus pandemic, markets reached as low as 35% down from their highs. In other words, it has officially entered bear market territory prior to a a rapid resurgence.
Nobody knows when a bear market will bottom out, but we always know how far down it is from its peak. If we act on known information rather than unknown information, we can always evaluate stock investment during a downturn as a measurable discount (in this case reaching about 35%) instead of a speculative bet on a further decline.
Fear of not buying at the absolute low point should not be a deterrent for buying this dip. Deciding to not buy the dip when you have the cash to do so should only be done if one of the next two options are more suitable for your situation…
Option 2) Pay down debt
Getting out of debt is generally a good thing, but it may be worth it during this time to further accelerate your payments if you are able to for one simple reason — you may not have the cash flow to make your payments in an uncertain future.
If you believe your job and future earnings are at risk due to the ripple effect of a recession, the last thing you want to do is to risk defaulting on your debt. Run the numbers to see if your ability to pay existing debts would be completely upended by a job loss, and evaluate your risk of actually having that job loss. It’s certainly possible that those two factors combined outweigh the huge growth opportunity that comes with buying the dip.
Option 3) Raise cash
The third option is to increase your cash position on new income (NOT by selling existing shares). Ideally, you don’t hold a cash position higher than 5–10% of your total assets unless it requires more than that to sustain 3–6 months of your expenses. Also, if you have a stable income even in the midst of a recession you may feel like a higher cash position may be unnecessary.
However, economic downturns, especially like what we briefly saw with COVID-19 and could see again from another wave or new variants, have the ability to disrupt supply chains so deeply that it may not be wise to assume a stable income remains stable for very long.
Early pandemic estimates indicated unemployment could have exceeded 30% (what does 30% unemployment even look like?). Former Chair of the Federal Reserve Janet Yellen also suggested that unemployment could exceed Great Depression peaks of around 24%. While mass vaccination occurred faster than expected, it's important to keep these figures in mind in the event of a similar situation in the future.
Cash doesn’t always feel necessary until it’s necessary, and by that point, it‘s a lot harder to generate.
So what should I do?
There’s no absolute right answer to the question and any combination of the options above can be used, but there are certain factors specific to your situation which may influence your answer.
If you are confident in your skillset (not just your company) being in a good position to withstand a recession, you may be more inclined to buy the dip and acquire assets at perhaps a once-in-your-lifetime discount. Examples related to the current situation the world is facing maybe if you work for a company offering sanitary supplies, streaming entertainment, video games, or home gym equipment or subscriptions. Buying the dip can also be a good option if you work in a less favorable industry but already have a large cash cushion to fall back on should things go south in a hurry.
The level of risk with your job or industry may dictate whether you choose to accelerate debt repayment or aggressively raise cash.
If you work in a field or industry more susceptible to negative impact, your strategy may instead be to pay down debt or raise cash. Obvious examples of this include the restaurant/hospitality industries or the travel industry, but think about whether less obvious examples put you at risk as well. For example, if you work for a clothing retailer, you may find the company not able to manufacture goods at the same rate, distribute to the same channels, or generate as much demand since customers have less money to spend. This may not result in a job loss at the beginning of a recession, but over 6–12 months it’s certainly not out of the question no matter how great of an employee you may be personalized.
The level of risk with your job or industry may dictate whether you choose to accelerate debt repayment or aggressively raise cash. Moderate risk may include the clothing retailer example, which may be more conducive to paying down debt. Higher risk may be working for a luggage manufacturer during times of drastically reduced travel, which may warrant stockpiling cash beyond the typically recommended 3–6-month cushion to perhaps a year or more.
Consider yourself extremely lucky if you are ever in the position where you have to make a decision about where to put surplus cash. That said, please consider the fourth and most important option — give back. Support your local businesses. Donate where you can. Solidarity goes a long way — dollar for dollar the best investment you can make.
This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
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