How To Make Lots Of Money During The Next Downturn

During the last downturn, I lost about 35% of my net worth in about six months. I don’t plan on doing that again.  

Losing 35% is not as bad as the S&P 500 losing ~60% during its worst period, but it still hurt like hell due to the speed and absolute dollar amount of the loss.

At the end of February 2020, the S&P 500 lost 10% faster than any other 10% correction in history. The the S&P 500 proceeded to collapse by 32% in March as the coronavirus pandemic grew. As a result, if we are equity investors, we must be extremely vigilant in guarding our net worth. 

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 as the world collapses all around.

Here’s how I plan to do it and how you might too if you’ve accumulated enough money or are planning to retire within the next five years.

How To Make Money During The Next 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 methodically sell off risk assets like stocks and real estate the longer we go in the cycle.

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.

If we are to say the recovery began in 2010, then 2018 is the 9th year of the current cycle. With the Fed starting to tighten, valuations close to all-time highs, and earnings growth slowing down, we can conclude it was logical to start taking some risk off the table in 2019. 

As the bear market is here in 2020, 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 ~1.70% 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.

One of the best online money market accounts by CIT Bank is right now yielding 1.7%. That is fantastic compared to the 10-year bond yield at only <0.7%. This is a positive arbitrage savers should take advantage of right now. 

If you have already made over a 200% return in the stock market since 2010, is it so bad to only make 1.7% 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.

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.

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.

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.

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 $33 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 2Q2020, the bond market has had a tremendous run with TLT now tremendously outperforming the S&P 500 year-to-date. The next time you look down on bonds, don’t. It’s nice to earn lower risk returns. 

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

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.

Again, you can earn a risk-free 1.7% in an online money market account with CIT Bank, compared to earning only <0.7% with a 10-year bond yield. This is by far one of the best risk-free arbitrage opportunity everyone should take advantage of right now. 

Making a guaranteed return of 1.7% 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.

Also check out Credible, my favorite lending marketplace where pre-qualified lenders compete for your business. It takes under three minutes to get a quote. Mortgage rates are now at all-time lows, so it’s best you take advantage and refinance to improve your cash flow!

If you can concurrently build outside income sources while you de-risk, then all the better.

Consider Diversifying Into Real Estate

With interest rates collapsing in 2020, 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. 

Real estate markets in the heartland of America where valuations are lower and net rental yields are higher look attractive. There should be a multi-decade demographic trend away from expensive coastal cities into lower cost areas of the country thanks to technology. 

CrowdStreet is my other favorite real estate crowdfunding platform, specifically focused on investing in commercial real estate in 18-hour cities that have faster demographic growth. It is also free to sign up and explore.

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.

Track Your Wealth For Free

Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.

After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms.

Updated as of 2Q2020. The coronavirus and plummeting oil are catalysts for a recession. Let’s hope it dies down by the end of summer and that a vaccine is created sooner rather than later!


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