Worried About a Recession? Patient Investors Can Ride It Out.

So many people expect a recession soon that it will almost be surprising if a downturn doesn’t happen.

After all, the Federal Reserve has been raising interest rates for more than a year to tame inflation. Credit conditions have already tightened and some regional banks have failed. Although the job market is still stubbornly strong, even the staff economists at the Fed anticipate an economic slowdown that will be severe enough to count as a recession.

That’s particularly worrisome for investors because recessions are typically associated with double-digit stock market declines. In 2020, for example, during a bear market and recession near the start of the coronavirus pandemic, the S&P 500 dropped nearly 34% from its peak.

Will we really have a recession this year? I don’t know. But recessions are a regular part of life. Having experienced six of them in my career, along with countless up and down markets, I accept that I can’t reliably forecast these important events, and neither can anyone else.

Yet I remain a constant investor anyway, mainly by keeping plenty of cash in safe places and by maintaining a resolutely long-term view that is grounded in history.

It’s not always easy to hang on. Uncertainty about what’s coming next can make investing excruciating. But you may find some comfort from the past.

Stocks have always bounced back after previous recessions, sometimes quite rapidly. Investment returns calculated at my request by Dimensional Fund Advisors, a large asset management company based in Austin, Texas, show that the market has performed reasonably well over periods of 10 or 20 years after economic downturns, if not always over shorter periods.

Calling Recessions

A recession is “a significant decline in economic activity that is spread across the economy and lasts more than a few months,” according to the National Bureau of Economic Research, the quasi-official entity that declares when recessions start and stop in the United States.

That sounds straightforward enough. But for a large and complex economy, determining when a recession has taken place is no simple matter, even after it has happened.

The bureau doesn’t rush in making these judgments.

We won’t know for sure that we’ve had a recession until well after it’s started, and, quite probably, not until long after it’s ended. That’s what happened for the last recession. It started in February 2020, near the beginning of the pandemic, and ended in April 2020. But the bureau waited 15 months, until July 2021, to declare that a recession happened.

“Earlier determinations took between four and 21 months,” the bureau says. “There is no fixed timing rule. We wait long enough so that the existence of a peak or trough is not in doubt, and until we can assign an accurate peak or trough date.”

Often, stocks fall before a recession starts and rise before it’s over.

The economic research bureau “dates recessions only after they’ve begun,” Marlena Lee, the global head of investment solutions at Dimensional Fund Advisors, said in an email. “Markets, on the other hand, call them well in advance.”

Historical Returns

At my request, Lee examined all 11 U.S. recessions since 1948 and calculated the S&P 500’s annualized total returns, including dividends, starting with the first day of the month after the recession started.

I find these averages reassuring:

— One year after the starting dates, the S&P 500 returned 6.4%.

— Three years after the starting dates, it returned 12.1%.

— Five years later, it returned 10.4%.

— Ten years later, it returned 12%.

— Twenty years later, it returned 11.5%.

Consider that, with compounding, $1 in the index would be worth $10.56 after 20 years, on average. So far, so good.

Now for the caveats.

These are only long-term averages, and there are big variations among them.

The best 20-year return, which occurred in the two decades starting in February 1980, was 17.2%, annualized. That would transform $1 into $24.02 after 20 years.

The worst 20-year return, in the decades starting in May 1960, was 7.3% annualized. That would have changed $1 into $4.09 after 20 years.

Obviously, I’d rather have $24.02 in my pocket but even $4.09 would have represented a sizable gain.

Nasty Losses

The variation in returns was much greater over shorter periods. One year after the recession of 1953, for example, an investment in the S&P 500 would have gained nearly 32%.

But some years were truly painful. The stock market was still down one year after the start of three recessions, in 1973, 1981 and 2007. The last of those was the financial crisis, and it was the worst.

One year after that recession began, the S&P 500, with dividends, was down 37%. Another way of putting it is that if you put $1 into the index at the start of the recession, it shrank to just 63 cents one year later.

After three years, you were still in a hole: Your dollar had grown to just 92 cents. After five years, in 2012, you were ahead, but not by much. Your dollar was $1.09. The total at the 10-year mark in 2017 was better: $2.26. The 20-year verdict isn’t in yet.

The most recent recession, the one that started in February 2020, led to excellent stock returns quickly, despite the initial losses. After one year, $1 had grown to $1.31; after three years, it was $1.41. I’m betting that it will keep rising over the next couple of decades, but there is no guarantee that it will.

The Takeaway

History is informative, but it doesn’t necessarily predict the future. These historical returns may not be echoed closely enough to serve as a reliable guide. If the stock market performs much better than it has in the past, wonderful. If it’s worse, you may still be all right if you are well diversified, with holdings in markets around the globe.

That said, as long as the economy keeps growing despite periodic recessions, and as long as markets operate relatively smoothly, there are grounds for both optimism and caution. While I’m a confirmed investor, I don’t risk money in the markets that I expect to need in the next three to five years.

For safety, I hold cash in a variety of places, including government money market funds and federally insured savings accounts. Bank certificates of deposit and Treasury bills are good options, too.

For the long haul, I invest in bonds as well as stocks in broad, diversified, low-cost index funds that mirror the entire world markets, spreading my risks. Tech stocks faltered, but energy stocks gained last year. Bonds performed miserably, but I expect they will be better in the years ahead. We’ll see about all of that.

Waiting many months for recession declarations, or relying on economists or Wall Street pundits to determine when to invest and what to hold all seem fruitless to me.

I’ll try to make sure that whatever happens, I can pay the bills first.

Then, I’ll continue making optimistic bets that over stretches of a couple of decades or more that the stock market will be higher than it is now, even after including those dreaded recessions.