What is a recession?
Very simply put, a recession is when there is significant decline in a country’s economic activity. The most popular rule of thumb to define when a country officially falls into recession is when the country’s gross domestic product (GDP) declines over two consecutive three-month periods – known as quarters.
Gross domestic product (GDP) measures the monetary value of final goods and services – that is those that are bought by the final user - produced in a country in a given period of time. (imf.org, 2020)
A healthy economy grows over time, so when we see consistent decline over two-quarters in a row, it is clear there are underlying issues in a nation’s economy. During a recession, companies will struggle, people will lose their jobs and the overall economy will struggle with output. And while recessions bring incredible hardship to individuals and businesses, they are considered a natural and inevitable stage of the economic life cycle.
What causes a recession?
Recessions can be caused a number of ways – including sudden economic shock (an example of this is the Coronavirus pandemic), asset bubbles, excessive debt, deflation and inflation, and vast technological change.
Deflation vs inflation. Inflation occurs when the prices of goods and services rise, while deflation occurs when those prices decrease. Central banks keep a keen eye on the levels of price changes and act to stem deflation or inflation by conducting monetary policy, such as increasing or decreasing interest rates. (Investopedia, 2021). The Bank of England’s target inflation rate is 2%.
Asset bubble. An asset bubble occurs when the price of an asset, such as stocks, bonds, real estate, or commodities, rises at a rapid pace without underlying fundamentals to justify the price spike. (Investopedia, 2022). A well-known example of this was the dotcom bubble in the late 1990’s where investors excitedly put billions of dollars into Internet-based start-ups in the hopes the companies would turn a big profit. But when the bubble ‘burst’ the market crashed by nearly 77%.
The leading cause of the Bank of England’s prediction that a recession is on the way is inflation. In August 2022, inflation surged to the highest rate in 40 years to 10.1% and shows no signs of slowing down, with forecasters anticipating a peak of 13% in coming months.
In an attempt to reduce inflationary pressure, central banks around the world have increased interest rates – in the UK the Bank of England raised interest rates in August from 1.25% to 1.75% - the sixth rise since December 2021.
The idea being that with increased interest rates, people are encouraged to save more and reduce their consumption of goods and services, as it becomes more expensive to spend and borrow money to afford these purchases. But it’s a double-edged sword, because increasing interest rates to reduce inflation may well push economies that are already struggling into recession.
How long will the recession last?
This will be the third recession the UK has experienced in the last 14 years, and the Bank of England predicts it will last around five quarters – that’s 15 months. The last time we had a recession of this significance was the 2008 Global Financial Crisis (GFC) - also dubbed as ‘The Great Recession’.
How to invest during a recession
One of the knock-on effects of people spending less and slowed economic growth is that businesses begin to struggle, and the value of stocks and shares decrease, affecting even the strongest portfolios. Investors should prepare themselves for more market turbulence ahead. However, having said that, even during a downturn, the stock market provides opportunity to grow your money if you take a long-term view. At OpenMoney we recommend a 5-year minimum strategy, based on data and historical trends.
Here are five key things to consider:
- Don't panic, and avoid knee-jerk reactions that don’t align with your long-term goals.
- Avoid checking your investments too regularly as this can cause unnecessary worry during volatile periods. A sensible approach would be to check every 3 – 6 months.
- Ensure your portfolio is diversified so that investment risk is spread out.
- Check your fees are low so they won’t be ‘eating away’ at your investments – it might be worth transferring your investments, but you should get financial advice first to make sure it’s the right decision.
- Take comfort from the past. Historically, there has always been market disruptions and recoveries – you just need to be patient.
What else can be done?
With all the above said, personal finances are also undoubtedly going to take a significant hit and households will suffer. Government intervention is certainly needed, but what’s important is that you focus on what you can control. Now is the time to sit down and really scrutinise your incomings and outgoings so you can take comfort in knowing that you are doing everything you can to maximise your money.
- If you don’t already have one, start building an emergency fund and contribute to it regularly – every pound matters. Ideally, an emergency fund holds 3-6 months’ worth of your expenses.
- Build a monthly budget and stick to it. It sounds so simple, but in practice it can be difficult. We have many resources to help you get started.
- Prioritise keeping your credit score high by paying bills and debts on time.
- Look for opportunities to save by switching providers, cancelling unused subscriptions, and using reward and loyalty programmes such as cashback sites.
- Finally, if you are thinking of starting to invest now or considering new investments to make your money work harder for you long-term, we’d be happy to speak with you. Either email, call or message us on Live Chat and we can put you in touch with one of our financial advisers directly.
Whenever you invest, your capital is at risk and there’s a chance you may get back less than you put in.