How to make money during a downturn

World Markets update

All eight indexes on our world watch list posted losses through April 6, 2020. The top performer is China's Shanghai with a loss of 9.38%. The S&P 500 is in second with a loss of 17.55% and in third is Hong Kong's Hang Seng with a loss of 17.57%. Coming in last is India's BSE SENSEX with a loss of 33.12%.

Here are all eight world indexes in 2020 and the associated table sorted by YTD.

The chart below illustrates the comparative performance of World Markets since March 9, 2009. By aligning on the same day and using a log scale vertical axis, we get an excellent visualization of the relative performance. The callout in the upper left corner shows the percent change from the start date to the latest weekly close.

How to make money during a downturn

1) Be okay with no longer making money

The first step is to be at peace with not making money. It hurts to miss out on gains but missing out on gains is one of the only ways to not lose money when markets are very unpredictable. Your goal is to time your asset allocation smartly and so that you have the least amount of risk exposure. The problem is, no one knows when the downturn will end.

It’s a fool’s game to try and predict market bottoms and tops, with most people ending up buying highs and selling lows. To get a better idea of where we are in the cycle, it’s important to study history and make an educated guess.

Bull markets last on average about 97 months (8 years) each and gain an average of 440 points in the Standard & Poor’s 500 stock index. By comparison, bear markets since the 1930s have an average duration of only 18 months (1.5 years) and an average loss in value of about 40 percent.

2) Be at least neutral when the cycle turns

In a downturn, the usual mantra is to ‘stay the course’ as stock markets always recover in the end and it also gives people the opportunity to buy things cheaper, make a ton of money on the boom, and without making any wild plays. However, each of us have different financial situations.

Let’s say you have £10 million and you can live off £250,000 a year. Do you really want to risk losing £4 million, (40% is the median market correction) when you can earn, let’s say - £300,000 a year from it sitting in a bank? Especially, if your net worth was only £3 million just 10 years ago.

By moving 70-100% cash and looking for safer investments (that are not tied to stock markets) you can protect yourself. Although you’re used to higher returns, a secure 1.75% for example, will feel much better when global markets are tumbling 2-3% every day.

3) Take some risk and go net short

Shorting the market long term is a losing proposition due to population growth, ever-growing demand, dwindling supply, and inflation. It’s the same concept as renting long term. But, the only way to make money is by taking risks and this leaves the possibility of being wrong and losing money.

If you want to short the market, you must be disciplined to short for only a short duration of time. Many investors looking to hedge against a downturn by building a portfolio of longs and shorts and re-balance their net exposure whenever they feel more bullish or bearish. But in such a scenario, you might lose on your longs and shorts as well.

Given you can mistime the market in both directions and none of the investments above are perfect hedges, the easiest way to make money during a downturn is to go long cash or cash equivalents but for investors that are more inclined to take risks – shorting markets are a great way to make a lot of money. If you still have another 20-30+ years worth of working you should continue to take risks, if you already have enough money then taking risks is unnecessary.

4) Safe haven assets

23rd March to date Gold has gained 15% 16th March to date the Dollar Index has gained 6% Riskier assets like the sterling, at it’s low, on the 16th March lost 15% value against the Japanese yen. Using market & risk sentiment is a great tool to gauge the demand for certain assets. In times of uncertainty, like recessions and wartime's, markets move in cycles and human behavior tends to repeat itself. Capitalizing on an increased demand for ‘safer’ assets is a great way to make a lot of money while the world is falling apart around you.

5) Real estate

Investors have flocked to real estate for shelter during difficult times before. This is what happened after the dotcom bubble burst in 2000. When banks are continuing to cut interest rates, an attractive idea is to start diversifying into real estate as lower interest rates makes it easier for people to purchase homes.

Often during recessions, we see house prices fall in value because there is usually an increase in supply to the market while demand continues to decline. However, in our current situation which is that the whole world is on lock-down, supply and demand are flat lining. We are seeing this because despite virtual viewings, there are little or no new offers coming in and the market is at a standstill. The shutdown has forced estate agents to close their offices and job uncertainty has caused demand to decline. Prospects for a productive spring and summer were good but now sentiment will remain the driving force moving forward.

Expectations that market prices and activity will plunge are increasing. The government may have to reintroduce measures such as a suspension of stamp duty to encourage buyers in the future.

6) Investing in the long term

Long term investments, such as the S&P 500 and real estate tend to go up and to the right. When you combine not spending money with long-term compounding, you will likely get rich beyond your expectations.

In conclusion, during downturns there are many ways people can make a lot of money, through selling off stock markets, buying safe-haven currencies and repurchasing discounted stocks. You must always ensure you are doing your due diligence – back test through previous recessions and see how your strategy would play out, you also need to consider your overall financial situation. If you have already made good money, liquidate your positions and wait for the market to recover to reinvest. Sometimes, not actively being in the market is an investment strategy within itself.

Experiencing difficult times will make you smarter about money. When times are good, we tend to forget about our investments, risk exposure and our financial goals. When things are correcting, we tend to pay more attention because we’re afraid we’re going to lose it all. Pain forces you to learn and change. Align your risk exposure with your tolerance and financial goals.

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