How To Invest In A Recessionary Economy
August 14th, 2007Disclaimer: I’m not a professional investor and this article should not be taken as investment advice. I am only trying to figure out what to do with my savings in the coming months as I get out of credit card debt.
Let’s just assume for this post that all the doom and gloom about the economy is right. How do I invest without losing everything to crashing markets? Let’s just go over the problems again:
- The dollar is devaluing substantially.
- Real estate prices are collapsing in many regions.
- Adjustable-rate mortgages have 2 more years of resetting to do before we are in the clear.
- Consumer debt was 2.4 Trillion dollars in the 2nd quarter of 2007.
Of course, there are some people who think that this is a temporary dip and that the bursting credit bubble will be limited to the sub-prime fiasco. Free Money Finance is looking to buy because it is a stock sale. Maybe they are right, but I’d prefer something a little more safe. The question is, what? I think these are the options:
- US Index Funds
- US Mutual Funds
- US Bonds
- European Funds
- Developing Market Funds
- Commodities
US Index Funds
These are in vogue right now because of their low fees and good performance. The trouble is, if you think that the market as a whole is going to lose value, you don’t want to be invested in an index fund that is going to mirror that loss.
US Mutual Funds
These seem to be the staple of investment. If you think some US sectors will escape the recession, you may be able to find a mutual fund that is concentrated in that sector. The problem of course is that a recession tends to hurt almost everything, so it isn’t likely that mutual funds will do that well either.
US Bonds
US Treasury bonds are about as safe as you can get. If you really think things are going to crash, this is the place to invest. Still, bonds don’t protect you from a devaluing dollar. You may be earning a safe amount of interest, but if prices are going up faster, you’re still losing money.
European Funds
The Euro is strong right now, and maybe Europe will escape a global slump. But then, who wants to buy into a foreign market when the dollar buys you so little? If you think the value of the dollar will go back up, you probably don’t want to invest in foreign markets only to lose money when you convert back to dollars in the future. Of course, the flip side is true also
Developing Market Funds
The economies of developing markets are pretty heavily dependent on US consumption, and if that consumption drops, we’ll probably see some losses here too. On the other hand, they aren’t as concentrated on the US market as they used to be, so maybe they will be fine. The other problem here is that many foreign banks and companies are pretty heavily invested in the US market, and will see some big losses if the stock market crashes.
Commodities
I have a friend who is considering this. It seems like commodities are the ‘nuclear option’. You don’t want to buy gold when the price has increased so substantially, but the question is whether the dollar will regain value or not. If you think it will, then you probably want to hold off, and if you think it won’t you probably want to buy.
To me there don’t seem to be any particularly good options, and a lot of what you choose will depend on how badly you think things will get over the next few years. Some people like Mish have some pretty convincing arguments for why the US economy is going to be in bad shape for a while. Personally I anticipate 3-5 years of declining real estate values, low consumption, and the loss of a significant number of government services as the country realizes that between the housing bubble and the Iraq war it has built up a lot of debt and now it has to pay for it. But I don’t think that the economy is going to revisit 1929 as some people are suggesting.
What does this have to do with decision making you ask? Obviously deciding what to do with your money, especially when trying to predict the future, is a pretty big decision. How can we use decision making tools to navigate through these waters?
It might be best to try and recognize unconscious influences on what we are thinking. You can look at the page on Decision Making Errors for a discussion of the different ways that we make mistakes when making decisions. Lets start with a list of what you think is going to happen. Here’s mine:
- Real estate prices continue to drop. Combined with foreclosures and stricter credit, the perception of wealth decreases drastically, and people spend a lot less money.
- The dollar continues to devalue as the fed prints more money to pay for it’s very very expensive war, further constricting the budgets of normal people and causing more debt, bankruptcy, and less consumption.
- The rest of the world enters a recession as losses from real estate investment and over-investment in the dollar mount.
One of the ways in which we are bad decision makers is that we tend to place more emphasis on information we see more often. This is why most people think crime is getting worse even though it’s been declining for several years: we see it on TV every day. We also put more emphasis on facts that support what we already think. As someone concerned about the environment, I reject anything that suggests that nuclear power is a good option, even though it may actually be a good option.
So we look for information that supports our point of view and believe things that we hear about more often are more prevalent. This is the main reason for media frenzies, and we’re having one right now about the impending credit bubble burst. The next step is to try and identify all of your sources of information related to the list of predictions you made above.
- Housing bubble and economic analysis blogs
- Google News
- Coworkers, friends, and professional associates
Well no wonder I think that the economy is going to crash! All I read are personal finance blogs and housing bubble economic blogs. On these blogs I’ve seen a total of two articles suggesting that there isn’t going to be a crash. If going against the crowd means smart investing, these guys are doing the right thing. On the other hand coworkers, friends and associates are all involved in economic analysis themselves, so if anyone has the data and a feel for where things are going, it should be us.
Lesson for the day: I don’t know that this was a particularly helpful decision making exercise, but it did leave me with the thought that I really should be more careful about reading a variety of information sources. I shouldn’t just subscribe to The Nation, I should also subscribe to a conservative paper. I should read articles from both bulls and bears. Baby steps though, I don’t think I’m ready to listen to Rush Limbaugh just because I also listen to NPR.
Update: Since writing this a number of people have posted some information on the same idea. Check out Investing in a down market at The Simple Dollar, and The Dow is falling at Generation X Finance.
Also, please share your investment strategy or thoughts on the current situation. Thanks!
-zot
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