How to Invest in an Economic Slump
Every economic environment presents investment opportunities. The problem with a slump is you can't use the same strategies you use during growth periods. In fact, you may have to consider some investment approaches you previously rejected. If you believe a slump won't last forever, you can invest from a new perspective: everything is going on sale. Make a plan for investing during a slump and you could profit when the economy begins to expand again.
Determine your time frame. If you see an economic slump on the horizon, estimate the amount of time you expect it to last and compare that to the amount of time you want to invest. For example, if everything you hear and read suggests a two-year slump followed by a slow recovery, and you see yourself building your investments for the next 10 years, you have an opportunity. During the slump, investment prices drop, allowing you to buy cheap. As the economy bounces back, prices rise, allowing you to do well even in a mild recovery.Step 2
Buy stocks using dollar-cost averaging. This strategy has you invest the same dollar amount each month or quarter. For example, invest $500 every three months into a growth stock. If share prices are high at investment time, you get fewer shares. If prices have dropped, you get more shares. Because you get more shares when the stock is cheaper, your average share price remains low. If the slump continues, you can get even more shares for your money. Dollar-cost averaging works well in a down market because you continuously buy more shares at a lower price until the market hits its bottom. You don't have to guess the exact bottom, because you buy cheaper shares every time you invest, and at some point you'll buy at or near the bottom. That purchase buys the most shares of all of your purchases.Step 3
Stop investing when the slump ends. It's hard to tell when a slump is over, but at some point you will realize that you have been paying increasingly high share prices for several months. Take a break and let the economy settle down. If it has entered a new era of expansion, you profit, because you bought shares when they were cheap. If it dips again, you can resume your dollar-cost averaging.Step 4
Add to your holdings during a true expansion, once you are convinced the economy is back on solid footing. Limit your new investment to an amount less than the total you invested with dollar-cost averaging. For example, if you invested a total of $10,000 while dollar-cost averaging, keep your additional investment below that figure. You will pay higher share prices, but since you bought so many shares at a low price, your average share price is always lower than the current share price. That means you can sell any time you want and still make a profit.
- If you think an economic slump is going to last longer than you have to invest, stay out of the market. Trying to profit when prices drop is what investors call "trying to catch a falling knife." You can get hurt guessing whether the market has gone as low as it's going to.
- Buying increasing lower-priced shares of a stock that is headed for zero will cause you to lose all of your money. Invest in stocks that you think can participate in the economic recovery.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.