How to Invest During a Recession

The stock market is sliding, lay offs are increasing and more and more people are applying for unemployment benefits. Rising commodity prices, especially oil and agricultural goods, are hitting the consumer hard, forcing households to spend more as a percentage of the family budget on gasoline and food.

Economists my quibble about whether the US is in recession or not, but one thing looks certain: things are going to get worse before they get better. Consumer confidence is low and falling. Whatever the reality is, shoppers certainly feel we're either in a recession or entering one.

So how does one invest in such an environment? This depends on the level of risk you are willing to assume.

T bills, CDs

If you're an ultra-conservative investor, parking your money in US Treasury bills or bank certificates of deposit (CDs) should suit you well. While the stock market sinks and shareholders see their investments dwindle in value, your savings will be accruing interest.

It may not be much, but a few percentage points' gain is better than losing money. Be aware, however, that your savings may be earning less than the rate of inflation, in which case the value of your money will be falling relative to the cost of goods.

You can buy T bills directly from the US government at the TreasuryDirect Web site. You can also buy exchange traded funds (ETFs) that invest in T bills: SHY, TIP, TLT, IEF.

To find the best local rates on savings accounts and CDs, go to Bankrate.com. Two online banks that offer competitive rates on savings accounts and CDs are ING Direct and HSBC.

Bonds

If you're willing to assume more risk, try bond funds. These tend to do well when stocks fall, and they should garner you higher returns than Treasury bills, CDs or savings accounts, although they don't have the full backing of the US government, as T-bills and FDIC-insured CDs and savings accounts do. (Unless you buy bond funds that invest in government-issued bonds, of course.)

Vanguard offers a wide range of bond funds, including those of the mutual fund variety and exchange traded funds that invest in bonds.

Fidelity has bond funds as well. Bond-focused ETFs are also offered by iShares.com and PowerShares (called "fixed income" products).

If you want to buy corporate bonds from a specific company, it's best to contact the firm directly.

Riskier Investments

For the investor who's more daring and is willing to buy stocks, recessions can be a great opportunity to buy low and ride a wealth-generating wave as the stock market rebounds. One thing to bear in mind is that the stock market tends to bottom out before a recession is over, so if you're going to ride this wave, start surfing early on in the economic downturn.

This is tricky, of course, as who knows how long a recession will last? The market may dip, rebound slightly, then dip again, lower. The economy may do the same: slow, pick up for a quarter or two, then slow again. This is why investing in stocks is not for the faint of heart.

The rule for investing in a recession, then, is to stick to your guns. If you buy at what you think is a low, and then the equity falls farther in price, don't panic. Hold.

Remember, it's not a loss until you sell it; until then it's only a "paper loss." Unless the security is extremely risky (like a small company stock), it'll probably rise again in value when the economy rebounds. (Although be aware that this could take years.)

How does one reduce risk when investing in a recession? Don't invest in individual company stocks--invest in a sector or a group of companies. Single company stocks are riskier because their value can fall for company-specific reasons. A lawsuit filed against a firm can cause its stock price to plummet, for example (this happened with tobacco companies). A CEO who ends up in prison can depress shares as well (remember Martha Stewart?).

ETFs

ETFs are uniquely suited to sector investing. There are many ETFs available and they allow investors to go as broad or narrow as desired. You can invest in an index fund that tracks the US stock market (VTI), for example, or zero in on particular sectors. XLF is an ETF that invests in the financial sector, for example, while ITB invests in home builders as a group.

A detailed list of ETFs can be found at Yahoo's ETF Center.

Bear Market ETFs

For those who like to gamble with their savings, you can always invest in bear market ETFs. These bet against the stock market, rising in value as the stock market falls. If you believe the recession has only just begun or will last a while, and you feel the stock market has further to fall, bear market ETFs enable you to profit from a further downturn.

Yahoo's ETF Center features many of these, from bear market ETFs that bet against the Dow, S&P 500 and Russel 2000, to sector-specific inverse ETFs that short a particular area of the economy. For example, SKF bets against financial stocks, while SRS shorts the real estate sector.

Be very careful using such investment instruments, however, because the tendency of the stock market is to rise over time, so bear market ETFs are not good long-term investments. (Thus it's best not to buy and hold these, as opposed to ETFs that "go long.")

For detailed information on bear market ETFs, visit the Web sites of ProShares and Rydex Investments, two companies that specialize in such investment vehicles.

NOTE: You invest at your own risk. The author and this Web site cannot be held responsible for investment losses incurred by readers of this article. (Be careful. You could lose your shirt.)