Should You Sell Your Investments Ahead of the Next Recession?

Since the Great Recession ended in 2009, we have been in the midst of the longest expansion in American history. The good times are rolling, which has led many economists to wonder:

When is the next recession coming?

This is a fair question. The economic history of this country tells us that a recession is coming at some point, and there are signs that a recession is coming sooner rather than later (more on that in a moment). But it is impossible to know exactly when the next recession will hit.

Still, that doesn’t stop investors everywhere from asking their advisors if they should:

• Sell everything before the recession and avoid taking the hit
• Move into a different type of investment to minimize the damage

These questions are totally understandable in the wake of the Great Recession, which was so much worse than what we’ve historically seen. Typically you see job loss and some declining profitabilities, but rarely do you see people’s lives totally blow up, which is what happened to millions of Americans. So if investors are gun shy when they hear “recession,” I get it.

With that said, there are three reasons why it’s unwise for investors to overreact to a looming recession that I want to unpack in this article. Before we jump into those, let’s start with an important question: why are investors even considering something drastic?

Letting Your Emotions Drive the Bus

As human beings, when we’re tempted to make rash, even unwise decisions, the root cause of that behavior is almost always fear. It’s our “fight or flight” response, and when we come up against the perceived threat of a recession tanking our investment portfolio, most of us default to “flight.” We want to get as far away from that threat as possible, which explains why millions of people walk into their advisor’s office and ask, “What should we do about this recession?”

When that fear is coupled with recency bias—in this case, the deep scars left on some by the Great Recession—the resulting fear response can become impossible to ignore. As an advisor, much of my job comes down to managing the emotions of my clients. The problem is that the data I have that proves their fear is unfounded doesn’t speak to the same part of their brain where that fear originates, making it much tougher to pull them out of that fear response.

If you let your emotions derail you from a carefully-crafted plan that you put together with your advisor when you were level-headed and calm, it almost certainly won’t end well.

The Next Recession Remains an Unknown

We actually discussed the first reason you shouldn’t overreact earlier in the article: nobody knows when the next recession is coming. Sound financial planning is built with timelines in mind. You have a plan for when you’re going to retire, when you’ll pay off your debts, and when you’re planning to make a big purchase, like an RV or a family vacation.

The next recession is a big question mark. We have data that shows us one is likely to happen soon, but there’s no guarantee of when. The data I’m referring to is the yield curve, which has become slightly inverted. A yield curve shows interest rates on bonds (usually treasury bonds) that mature from 30 days to 30 years, with lower rates on shorter maturities.

A normal yield curve slopes up from left to right, but what we’ve started to see is that rate flatten out, to the point where you almost get the same yield if you’re buying a 30 day treasury bill versus a 30 year note. The dip came on the long end, with 30 year rates lower than some of the more intermediate rates, which is very often an indicator that there is going to be a recession.

So, if you’ve heard chatter about a looming recession, that’s one of the reasons why. But again, no indicator can give us a foolproof expectation of when a recession is coming. Any advisor will tell you: making decisions based off an unknown future event is not a sound approach.

Examining Previous Shocks to the System

Over the past three decades, the American economy has endured some serious shocks to the system. No doubt, these earth-shattering events had both global ramifications and personal consequences for millions of Americans. And yet, when you zoom out a bit and look at the data, you see that much like the American people, the American economy is incredibly resilient.

Look at the chart below, which shows the market’s response to seven crises since 1987. If you had a mix of 60% stocks and 40% bonds, here’s how your returns would have fared:

As you can see, five of the seven crises had a positive return one year out from the event. The double whammy of the dotcom bubble burst along with the September 11th attacks suppressed returns for a while, but by 2006, you were seeing an 81% return. Even after Lehman Brothers went bankrupt in the midst of the Great Recession, you saw a 4% return a year later.

This brings us to the second reason you shouldn’t overreact: historical data shows that things are unlikely to be as bad as you think. Remember, we live in an era of clickbait headlines and fake news. Don’t trust people who are trying to sell you something—trust the data.

Trying to Time the Markets Doesn’t Work

Let’s say that a recession does happen in the next twelve months. Consider both the options we looked at earlier: sell everything or shift into a different investment. Starting with the latter, keep in mind that whatever you shift into will be affected by the recession. You can’t escape the blast radius by switching to utility stocks. It’s not “more stable” because it’s all in the same pot!

So, let’s say you decide to sell and enjoy a temporary relief because you’ve escaped the anxiety you were feeling about the recession. That’s the good news. The bad news is that you’ve actually just doubled your anxiety without realizing it. Now, you’ve got to angst over:

1. Did I make the right decision by selling off my investments?
2. When is the right time to buy back in?

You’ve probably heard it said before, especially if you work with an advisor, but timing the market doesn’t work. To prove it, here’s another chart showing what would’ve happened to a $1,000 investment from 1990 to 2018 if you’d missed some of the best days of returns:

Twenty-eight years is 10,227 days. Just by missing the 25 best days during that time, your return would’ve been chopped down by almost $10,000. Trying to time the market is such a risky game that smart investors know not to play it. They sit pat and stick to their plan.

That’s the third and final reason not to overreact: it’ll likely be costly and you’ll probably regret it.

Patience and Perseverance Are Rewarded

Like I said in the beginning, I understand why investors bring this question to their advisors. We’re all human, after all, and there are times when we all have doubts and anxiety.

The key point is that you can’t hand the keys to your financial future over to your fear. That’s when rash decisions are made, money is usually lost, and regrets are born. Worrying about the here and now often clouds our view of what can happen long-term if we’re patient. As this final chart shows, the US dollar has survived all number of disasters that could’ve broken us:

There will be ups and downs when you’re an investor. That’s just the way it is. It’s natural to get freaked out when you read that a recession is looming. My advice is don’t panic and make a rash decision. Talk with your advisor about what—if anything—should be done. If they have your best interest at heart, more than likely they’ll encourage you to sit tight and stay the course.

Whatever is going to happen has happened before, and just like back then, this too shall pass.