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Recessions are scary but historically the best time to invest. Here is what to do (and what not to do) with your money when the market drops 20, 30, or even 40%.
The stock market is down 25%. Headlines scream recession. Your 401(k) balance dropped by $30,000 in two months. Your coworker cashed out and went to bonds. Your parents are telling you the market will never recover.
Every fiber of your being wants to sell everything and hide in cash.
Do not.
History is unambiguous: investors who stay invested (or increase their investments) during recessions build significantly more wealth than those who sell. The S&P 500 has recovered from every single bear market in its history, every crash, every recession, every crisis, and gone on to new highs. The 2008 financial crisis? Recovered by 2013. The 2020 COVID crash? Recovered in 5 months. The dot-com bust? Recovered by 2007.
Recessions are when wealth transfers from the panicked to the patient. Here is how to be on the right side of that transfer.
What happens to investments during a recession
A recession is defined by the National Bureau of Economic Research (NBER) as a significant decline in economic activity spread across the economy lasting more than a few months. The stock market often (but not always) declines before and during recessions.
Since 1950, the US has experienced roughly 11 recessions. The average stock market decline during these periods was roughly 30%. The average recovery time was 2 to 4 years. Every single time, the market not only recovered but exceeded its pre-recession high.
According to data from NYU Stern, the average annual return of the S&P 500 is roughly 10% including dividends. Recessions are baked into that average. The 10% includes the crashes.
When you invest through a recession, you are buying the same companies at lower prices. The same shares of VTI or an S&P 500 index fund that cost $100 before the recession might cost $70 during it. Your automatic contributions buy more shares at lower prices, which amplifies your returns when the market recovers.
The biggest mistake: selling during a downturn
According to J.P. Morgan Asset Management research, missing just the 10 best trading days over a 20-year period reduces your returns by more than half. And the best days almost always occur right after the worst days, during the recovery that follows the panic.
$10,000 invested in the S&P 500 from 2003 to 2023:
- Stayed fully invested: $64,844
- Missed 10 best days: $29,708
- Missed 20 best days: $18,070
- Missed 30 best days: $12,354
The problem is that you cannot sell to avoid the worst days and get back in for the best days. They happen almost simultaneously. Selling during a crash means you almost certainly miss the recovery bounce, which is where most of the long-term returns come from.
This is why the phrase “time in the market beats timing the market” is not just a cliche. It is mathematically verifiable.
What to do during a recession
Keep investing on schedule
If you have automatic contributions to your 401(k), Roth IRA, or taxable brokerage account, do not stop them. Do not reduce them. If anything, increase them.
Dollar-cost averaging (investing a fixed amount at regular intervals) works especially well in downturns. When prices are low, your fixed contribution buys more shares. When prices recover, those extra shares are worth more. This is the mathematical advantage of consistent investing through volatility.
A person who invested $500/month in the S&P 500 from January 2007 through December 2012 (encompassing the entire Great Recession) had roughly $46,000 and a significant gain, despite the market losing 50%+ during that period. The shares bought at the bottom dramatically boosted their average return.
Protect your emergency fund
Before worrying about investments, make sure your emergency fund is solid. Recessions bring layoffs. Having 3 to 6 months of expenses in a high-yield savings account means you do not have to sell investments at a loss to cover bills.
If your emergency fund is not fully funded, prioritize that before increasing investment contributions. The worst financial outcome during a recession is being forced to sell stocks at the bottom because you have no cash cushion.
Rebalance your portfolio
A 30% market drop changes your asset allocation. If your 3-fund portfolio was 80% stocks and 20% bonds, it might now be 70% stocks and 30% bonds (because stocks fell and bonds held steady or rose).
Rebalancing means selling some bonds and buying stocks to restore your target allocation. This systematically forces you to buy stocks when they are cheap. It feels counterintuitive (buying the thing that is dropping), but it is the disciplined approach that maximizes long-term returns.
In retirement accounts (401(k), IRA), rebalancing has no tax consequences. In taxable accounts, consider directing new contributions to the underweight asset class instead of selling.
Look for tax-loss harvesting opportunities
If you invest in a taxable brokerage account, a recession creates tax-loss harvesting opportunities. Sell investments that are at a loss and immediately buy a similar (but not identical) investment to maintain your market exposure. The realized loss offsets capital gains and up to $3,000 in ordinary income per year.
For example: sell VTI (Vanguard Total Stock Market) at a loss and buy ITOT (iShares Total Stock Market) or SCHB (Schwab Total Stock Market). You maintain the same market exposure while locking in a tax benefit. The IRS wash sale rule prohibits buying the “substantially identical” security within 30 days, so use a different fund tracking a similar index.
Robo-advisors like Betterment and Wealthfront do this automatically.
Consider Roth conversions
A recession is one of the best times to do Roth conversions. When your Traditional IRA balance is down 30%, you can convert the same number of shares to a Roth IRA at a lower dollar amount, paying less tax on the conversion. When the market recovers, the growth happens inside the Roth IRA, tax-free.
Example: Your Traditional IRA holds $100,000 in index funds. The market drops 30%, bringing the value to $70,000. You convert the full amount: you pay tax on $70,000 instead of $100,000, saving roughly $6,600 in tax at a 22% rate. When the market recovers and the Roth grows back to $100,000+, that growth is tax-free forever.
Avoid these temptations
Do not move to all cash. You have to time two decisions correctly: when to sell and when to buy back. Most people get one or both wrong.
Do not move to all bonds. Bonds provide stability, but a portfolio that is too conservative in your 20s and 30s costs you decades of growth. Your asset allocation should not change based on market conditions. It should be based on your time horizon and risk tolerance, which do not change because the market dropped.
Do not stop your employer match. Your employer’s 401(k) match is free money. Even if the market is down 40%, the instant 50 to 100% return from the employer match dwarfs any market loss.
Do not check your portfolio daily. Set a schedule: check monthly or quarterly. Daily checking during a recession is financial self-harm. Every look triggers an emotional response that can lead to poor decisions.
Do not listen to market predictions. Nobody, including professional investors, consistently predicts market bottoms or recoveries. According to SPIVA scorecards, over 90% of actively managed funds underperform their benchmark index over 15-year periods. If professional fund managers cannot time the market, neither can you.
What if you have cash to invest during a recession?
If you have a lump sum (inheritance, bonus, savings beyond your emergency fund), a recession is a great time to invest it. But the temptation is to wait for “the bottom.”
The problem: nobody knows when the bottom is until after it has passed. Research from Vanguard shows that lump-sum investing beats dollar-cost averaging roughly two-thirds of the time, because markets go up more often than they go down. Even investing a lump sum right before a crash, over a 10+ year time horizon, historically produces positive returns.
If the psychology of investing a lump sum during a downturn is too stressful, split it into equal portions and invest over 3 to 6 months. This is not optimal mathematically but is optimal emotionally, and an imperfect plan you stick with beats a perfect plan you abandon.
Recession-proof your finances before the downturn
The best time to prepare for a recession is before it starts:
Build a 6-month emergency fund. Cash in a high-yield savings account is your recession insurance. It prevents forced selling.
Pay down high-interest debt. Credit card debt at 24% APR is devastating during a recession when income might be reduced. Eliminate it before the downturn.
Diversify your income. A side business, freelance skills, or an in-demand certification reduces the risk of a single-income dependency. Negotiating your salary and skills during good times creates a buffer for bad times.
Maintain your asset allocation. A 3-fund portfolio or target-date fund with an age-appropriate bond allocation provides built-in downside protection. The bonds in your portfolio cushion the fall.
Avoid lifestyle inflation. A lower baseline spending level means a recession requires less income to maintain your lifestyle and less emergency fund to cover the gap.
Frequently asked questions
Should I sell my stocks before a recession? No. Nobody can consistently predict when recessions start or end. Selling locks in losses and creates the timing problem of deciding when to buy back. Stay invested and keep contributing.
Is a recession a good time to start investing? Yes. Buying during a recession means buying at lower prices. Historically, investors who started during downturns earned higher long-term returns than those who started during peaks, because they bought their initial shares at a discount.
What should I invest in during a recession? The same things you should invest in during a bull market: diversified, low-cost index funds. Do not try to pick “recession-proof” stocks or time sector rotations. A 3-fund portfolio gives you the diversification you need in any market environment.
How long do recessions last? The average US recession since 1945 has lasted roughly 10 months, according to the NBER. The shortest was 2 months (COVID, 2020). The longest was 18 months (Great Recession, 2007 to 2009). Even the longest recessions are brief compared to the decades of growth that follow.
My 401(k) is down 30%. Should I change my investments? No. A 30% decline is painful but temporary. If you are under 50 and invested in age-appropriate funds (target-date or equity-heavy allocation), stay the course. Changing your allocation during a downturn is the investment equivalent of driving based on the rearview mirror.
What about bonds during a recession? Bonds typically hold steady or rise during stock market crashes (flight to safety). Your existing bond allocation provides a cushion. This is why a diversified portfolio includes bonds, not because they generate high returns, but because they reduce the severity of drawdowns and give you assets to rebalance into stocks.
The bottom line
Recessions are temporary. The emotional response they trigger can cause permanent financial damage if you sell at the wrong time. The investors who build the most wealth are not the ones with the best market timing. They are the ones who kept investing through every downturn without flinching.
Your strategy during a recession is the same as your strategy during a bull market: invest consistently in diversified, low-cost index funds. Keep your emergency fund intact. Do not change your allocation based on headlines. The only difference is that during a recession, every dollar you invest buys more shares and produces higher future returns.
The market will recover. It always has. Your job is to still be invested when it does.
Keep investing through every market cycle