During the 2008 – 2009 recession, I lost about 35% of my net worth in about six months. I don’t plan on doing that again. I want to share how we can make lots of money during the next downturn. We could be in one right now as the Fed aggressively raises rates and takes away our easy money.
So far in 2022, the S&P 500 has given up all its 2021 gains. Real estate is still holding strong, outperforming the S&P 500 by over 25% in 2022.
I don’t think there will be a housing market crash as demand fades with higher interest rates. Although rates went up aggressively in 2022, they are starting to decline again in the second half as a recession gets baked in.
If you want to make a lot of money during the next downturn, investing in real estate is probably one of the best ways to go. Real estate is less volatile, produces income, and provides utility. We saw real estate significantly outperform after the 2000 downturn.
I expect real estate prices to go down by 8% in 2023 due to a slowing economy and an aggressive Fed. But that means there will be buying opportunities.
Realistically, my target net worth growth scenario during a recession is to stay flat – neither make nor lose money. This is the first rule of financial independence. But my blue sky scenario is to actually try and make lots of money during the next downturn.
How To Make Money During The Next Downturn
Here’s how I plan to make money during this downturn.
1) Be OK with no longer making money.
The first step to making money during the next downturn is to be OK no longer making money during an upturn. In other words, you must be mentally OK. So much about investing success is having the right mental fortitude to last through the downturns.
It hurts to miss out on gains, but missing out on gains is the only way to not lose money. Your goal is to time your asset allocation so that you have the least amount of risk exposure when the cycle turns. The problem, obviously, is that nobody knows when the cycle will turn.
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.
With the Fed starting to tighten, valuations close to all-time highs, and earnings growth slowing down, we can conclude making money in stocks is no longer going to be easy.
As the bear market is here again in 2022, we must be OK with no longer making money. We must also accept no longer making as much money in our businesses and in our jobs. This acceptance will help with your mental health.
Related: How Much Investment Risk To Take In Retirement
2) Be at least neutral when the cycle turns.
Remember, even if you move to 100% cash or CDs, you are still going to make a guaranteed ~2%+ on your money each year based on today’s risk-free rate. You must weigh your guaranteed return against the possibility of missing out on further gains or the possibility of losing money.
If you have already made over a 250% return in the stock market since 2010, is it so bad to only make 1% a year instead of potentially 8% a year if you have to take more risk and potentially also lose 10 – 15% a year? Of course not. Having cash, bonds, and CDs is all about capital preservation not about making lots of money.
If your property equity is up 500% since 2012, do you really want to pay three more years of property tax, mortgage, and maintenance expenses if prices might stay flat or go down 20%? These are some of the questions you should ask yourself.
In addition to CD accounts, CIT Bank also offers the highest rate money market accounts and savings builder accounts I’ve seen.
It’s easy to set up a secure account online without ever needing to step into a branch. You can access your account info 24/7. And their customer service team is available to help with questions six days a week.
3) Take some risk and go net short.
The only way to make a lot of money in a downturn is to take risk. This means losing money if the downturn never comes. However, rich central bankers are very focused on protecting their legacy and crushing the economy to tame inflation.
The easiest way to short risk is to buy an ETF that goes up when the underlying index it tracks goes down. Here’s a list from ProShares which includes leveraged short and long ETFs to really juice your returns or blow yourself up.
You can also short individual stocks as well if you feel you have an edge and want more direct exposure. The stocks that usually get hammered the most during a downturn are high beta stocks with weak balance sheets and no earnings.
In other words, small cap names in the biotech and tech sectors often go down the most because their valuations are all based on speculative terminal values. Such companies will be relentlessly attacked on the short side as speculation grows they will go out of business.
Company Balance Sheets Matter
If you’re a loss-making company with no moat like Uber, you will die if the downturn lasts long enough because the capital markets will be shut to any fundraising. This is why shorting the Russell 2000 small cap index (TWM) is quite popular in a bear market.
On the other hand, cash-rich, mega capitalization companies that have a long history of paying a dividend tend to go down the least. Think about names in the utilities space and consumer staples space like AT&T or Proctor & Gamble. They are not only highly profitable, but also have enough cash to last them through years of unprofitability.
Thus, given we know the average recession lasts only 18 months, many investors seek relative safety by buying utility or consumer staple stocks. Unfortunately, the signs of a recession happening are increasing over the next 12-24 months.
Beware, if you short a high dividend yielding sector or stock or treasury bond ETF, you will be forced to pay that dividend.
Related: The Proper Asset Allocation Of Stocks And Bonds By Age
4) Go Long Volatility
You can also go long volatility by buying a volatility ETF such as VXX. During the early 2018, 10% sell-off in the S&P 500, the VXX doubled from $25.68 to $50. The same thing has happened with the August 2019 sell-off Just beware that going long volatility for the long term is a losing proposition due to a thing called “decay.”
The chart below is a 5-year history of the VXX. Notice how the price was $1,090 back on August 1, 2013. Today it’s only at $30 for a 97% loss! In other words, you can only go long volatility for brief periods of time (less than a couple of months) before the structure of the investment drags you down.
Related: It Feels A Lot Like 2007 Again: Reflecting On The Previous Peak
5) Go Long US Treasuries
When the world is collapsing, investors tend to seek the safety of US Treasury bonds. Two of the most common ETFs to buy are IEF (iShares 7+ Year Treasuries) and TLT (iShares 20+ Year Treasuries). Buying TLT will give you more upside and volatility given longer duration bonds are more sensitive to interest rate changes.
Notice how TLT spiked from $92.83 on Oct 1, 2008 to $119.35 on Dec 1, 2008 (+28.6%) during the depths of the financial crisis. There have been several more 20%+ trading opportunities since 2008 due to geopolitical risk, policy risk, and further stock market sell-offs.
It’s interesting to note that even if you had bought TLT at its high during the crisis, you’re back to even today while earning a steady ~3% annual yield.
As of 2Q2022, the bond market has now gotten crushed due to high inflation. With the 10-year bond yield at ~3%, I’m a better buyer today.
Related: The Case For Buying Bonds: Living For Free And Other Benefits
6) Go Long Gold
Gold is a hard asset that also tends to do well during a downturn. Even though gold generates no earnings and provides no dividends, it’s a commodity that can be traded. The more dire the economic situation, the more valuable hard assets become.
The largest, most popular gold ETF is GLD, followed by IAU. As you can see from the GLD historical chart below, it did phenomenally well from Oct 1, 2008 up until early 2012 (+170%) before fading as the bull market took off.
If you invest in gold for the long-term, it’s important to understand global demand and supply dynamics, and take a view on the US dollar since gold is denominated in US dollars. Gold is an imperfect hedge.
7) Go Long Yourself By Building More Skills
The people who don’t lose their jobs in a recession are those who are too valuable to their firms. Therefore, build enough skills, client relationships, and internal goodwill to be forever employed. You are likely your largest money maker.
Going to business school part-time was one of my best money makers because not only did I build new skills, my firm felt they had invested too much in me by paying 85% of my tuition to just let me go. They wanted their three years of indentured servitude in return for tuition assistance.
Besides getting more formal education, you should put some time aside each week to exercise your creative mind. Maybe you’ll write a counter-cyclical book, or come up with a song that earns royalties, or start a website that earns advertising revenue about your favorite hobby. These extra engines could blast you off into financial space.
Thanks to Financial Samurai, my overall net worth has outperformed the S&P 500 and San Francisco real estate since it began in 2009.
The Easiest Way To Make Money In A Downturn
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.
If you want to short the market, you must be disciplined to short for only a short duration of time. It could be only one week if you are buying volatility or at most two years if you are shorting the S&P 500. During this shorting time period, you will likely lose money as your timing will be imprecise.
As a result, many investors looking to hedge against a downturn build a portfolio of longs and shorts and rebalance 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.
Consider Risk-Free Investments
Again, you can earn a risk-free return in an online money market account. Or, you could earn a risk-free return investing in the 10-year bond yield. But with a 10-year bond, you’ve got to hold it for 10 years to guarantee you get such a return.
Making a guaranteed return low return may not seem like much, but it will feel like a fortune when the S&P 500 is correcting 3% a day!
The other obvious way to make a guaranteed return is to pay down debt or refinance your debt. Don’t let your lenders make money off you while the world is falling apart. Make money off yourself. The very least you should do if you have mortgage debt is to refinance it ASAP with interest rates falling to all-time loans.
Consider Diversifying Into Real Estate
With interest rates collapsing, another defensive way to make money is to diversify into real estate as real estate becomes more affordable. Given real estate provides utility, has sticky rents, and is a tangible asset, investors have flocked to real estate for shelter during difficult times. This is what happened after the dotcom bubble burst in 2000.
Instead of leveraging up to buy a single property, it’s probably better to avoid concentration risk and diversify into REITs or real estate crowdfunding.
Fundrise is my favorite real estate crowdfunding platform that’s free to sign up and explore. In an inflationary environment, investing in a diversified eREIT by Fundrise makes sense. Inflation acts as a tailwind for asset price appreciation.
The Fundrise platform portfolio has consistently outperformed stocks during down years and times of volatility. If you like less volatility and more stable returns, Fundrise is something to look into.
Take a look at the performance record below.
Look At Individual Real Estate Deals
CrowdStreet is my favorite real estate crowdfunding platform for accredited investors. CrowdStreet focuses on commercial real estate in “18-hour cities” that have faster demographic growth, lower valuations, and higher net rental yields.
We’re talking about cities such as Charleston, South Carolina and Memphis, Tennessee where cap rates are 3-5X higher than 24-hour cities like San Francisco and New York.
Thanks to the rise of remote work and working from home due to the global pandemic, it only makes sense that more and more people will relocate out of expensive cities with high density and into lower cost cities with lower density.
This is a multi-decade trend that is being take advantage of by savvy investors. CrowdStreet is also free to sign up and explore.
I’ve personally invested $810,000 in 17 commercial real estate properties across the country after selling my main single family rental for $2,745,000 in 2017.
It feels great to diversify and earn income passively. Just make sure you read all the material and understand what you are investing in.
Continue Investing For The Long Term
For those of you who are under 40 or who have at least 20 years of work left in you, you might as well keep taking risk based on a more traditional asset allocation model. Stay disciplined with your dollar-cost-averaging approach.
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.
For those of you who have enough money to be happy, taking excess risk is unnecessary. Once you’ve made your money, the key is to keep it.
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How To Make Lots Of Money During The Next Downturn is a Financial Samurai original post. How to Prepare For A Recession is a FS original post too. The time to raise cash and button down spending is now.
During a downturn, having a good amount of cash to cover your living expenses for 6+ months is very important. CIT Bank is currently my favorite online bank where you can earn maximum interest in a money market account.
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One problem I’ve had with a lot of the advice here is that it often requires you completely selling out of all of your positions. It’s sort of silly to have money tied up in an S&P 500 index while simultaneously snorting the market. You are essentially betting against yourself.
And selling your long positions causes tax issues and missed dividend payments.
I always preferred just to ride it out. My net worth may suffer but eventually it always bounces back.
Most of those market timing strategies listed above can end up doing more harm than good if your timing is not impeccable. Selling all your long positions to buy shorts after a 20% drop is more likely to lose you even more.
Hello there,
I was wondering when this post originally went up? There is an updated date of 5/2020 but there are comments dating back to 2018. This would answer my questions about the fact that if I had come across this type of information within the last 6 months this would have provided lucrative guidance to move my 401k to the short options from your graph. Upon analyzing the TWM Ultra short, had I moved the distribution I initiated in January 2020 it would have over doubled in value in mid March. Have I completely missed this opportunity now?
Given the S&P 500 and many stocks have rebounded by over 30% from its March 2020 lows, we’re in a tricky situation now. The market is discounting a lot of recovery and a quick recovery in 2H2020.
After the rebound, I think a wise move is to de-risk. Let’s thank our lucky stars the market didn’t tank further.
I do believe there’s a 30% chance we re-test the lows. The more likely scenario is that we remain rangebound 2,600 – 3,000 for the rest of the year. But it is possible we reach new all-time highs with so much devastation around us due to these reasons.
Seems relevant article for today’s market. There are some pretty good arguments against holding these… read one at etfcom titled “dont-buy-and-hold-leveraged-etfs” and was curious your thoughts on “timing” if these leveraged ETFs are not made to be held.
Or… just stick to the same investment plan you have always had and rebalance as needed. Keep investing monthly if you are able.
People.who get crushed are those who didn’t keep a safety net during.the boom years and are forced to sell.
Trying to time the market is a fools errand.
Thousands.of studies have confirmed this.
The only days that.matter are the day you buy and the day you sell. Most sell at the bottom and buy at the top.
“Trying to time the market is a fools errand”. vs “The only days that.matter are the day you buy and the day you sell.” ?
Virtually no one can consistently predict when the market will go up, or go down- therefore trying to time it is foolish. Many many studies show this. Warren Buffet admits as much.
Reading:
The Intelligent Investor
A Random Walk Down Wall Street
Bogleheads Guide to Investing.
Rich Dad Poor Dad
The only day that matters is the day you buy and the day you sell… What is meant is the fluctuation of the value of a security between these two dates is irrelevant to the return.