Here's Why Recession Warnings Shouldn't Stop You Investing This Year

Don't let gloomy predictions stop you from building wealth.

It isn't easy to invest when headlines are filled with predictions of economic doom and warnings that the sky is about to fall in. But a recession shouldn't stop you from building wealth, depending on your financial situation. Here are three reasons to keep investing, even amid warnings of a recession.

Investing during a recession

One common way to define a recession is as two consecutive quarters of decline in a country's gross domestic product (GDP). Recessions often mean a drop in stock prices and increased unemployment, and people may hesitate to buy stocks as a result. It's often harder to borrow money during economic downturns, too.

There's one important thing you should know about recessions: They are a normal part of economic cycles and they always pass, eventually. That means if your emergency savings are in good shape and you're investing for the long term, it likely makes sense to continue to contribute to your brokerage account.

1. Historically, the stock market has always recovered

There are no guarantees when it comes to investing, but over the past 30 years, the S&P 500 has delivered average compound returns of over 10%. Not only that, but the stock market has always recovered from crashes. As an investor, there are two conclusions we can draw from this:

• Stock prices should come back up -- even if they get worse before they get better.
• A recession can be an opportunity to pick up quality equities at lower prices.

If you are worried about buying stocks only for the market to fall further, consider dollar cost averaging. It essentially means investing the same amount of money at regular intervals, and can mitigate some of the risk of market turbulence. For example, you might invest $500 on the first day of every month, no matter what else is going on. It takes a lot of the emotion out of investing and means you're not so exposed if prices fall shortly after you buy. You may already practice dollar cost averaging if you make regular contributions to your 401(k) or IRA.

2. You can manage the amount of risk you take on

Investing always involves risk management, but even more so when there may be an economic downturn on the horizon. Look at your portfolio and consider whether you're comfortable with your exposure. One great way to manage risk is to build a diversified portfolio with a mix of different types of assets, including stocks, bonds, commodities, and real estate. If you own a mix of assets, poor performance in one area is less likely to derail your financial security.

It's also important to look for diversification within each asset. Rather than only focusing on, say, tech stocks, a balanced portfolio would give you exposure to a mix of sectors. If you don't have the time (or inclination) to research individual equities, look into index funds or ETFs (exchange-traded funds). These can give you exposure to a good mix of high-quality companies in one fell swoop.

The amount of risk you're willing to take on will depend a lot on your personal situation. Someone who is nearing retirement will likely be more cautious than someone who's just starting out in their career. Even so, for most investors, a recession is not the right time to buy risky stocks. The stock market overall should recover, but individual companies may fail. Stick to less speculative investments for now.

3. It's almost impossible to time the market

When financial experts are telling us we could be in for more stock market pain, there's an understandable temptation to hold off on investments so that you can buy when prices are lower. The trouble is that it's almost impossible to catch the absolute bottom. Moreover, we don't know what will happen in the coming year.

We're coming out of an unprecedented global pandemic, and it has skewed many of the indicators economists use to predict what might happen next. Sure, some people think stocks will fall further. But others say we can still avoid a recession and that the economic difficulties are already priced in. Don't try to buy at the absolute bottom. A better bet is to consistently invest over time and look for quality assets that you believe will perform well in the long term.

When you shouldn't invest -- whether there's a recession or not

There are some solid arguments for making consistent investments in your future. Indeed, it's the way many self-made millionaires built their wealth. However, it won't be the right move for everybody, especially if the economy worsens. Here are some scenarios where it makes sense to hold off:

• You will need the cash in the short term. Investing is a long-term game, so if you think you'll need that money in the coming, say, five years, don't put it in the stock market. Instead, look for a safer place to put that cash, such as a high-yield savings account.
• You carry high-interest debt. If you're carrying a balance on your credit card, pay this off before you buy stocks. The average APR on a credit card is around 15% to 20%, which is higher than the returns you might get on many investments.
• You don't have an emergency fund. Having three to six months or more of emergency savings means you won't have to take on debt or sell your investments (potentially at a loss) if something unexpected happens. Whether it's a job loss or medical emergency, it's important to be prepared.

Bottom line

The decision to invest depends as much on your financial situation as it does on market conditions. Investing can help build wealth, and recessions can offer opportunities to buy while prices are low. But if you carry debt or don't have emergency savings, prioritize these over any stock market investments. That way you can invest further down the road from a position of financial strength.