Study Of Suitable Investments During A Recession Period Finance Essay - Free Essay Example

According to Stormy Brain (2008) Keith Robert (2003, p. 31), the key to investing during a recession is to start off with the right mentality and do not panic. They also lay the groundwork for opportunities in the future even recession can be scary. Interest rates fall and it becomes less expensive to borrow money. Cost-cutting processes can teach a company to become more innovative and competitive. The lower demand for products and services brings down the effects of inflation. Warren Buffet, George Soros (1995), Mary Jaksch (2009) also believed that stock market timing is not exact, but chances are that if you invest during a recession, once the market has recovered you will benefit from the increase in price that your investment will bring by way of profit when you do decide to sell. Recession may not seem like the best time to be investing your money but just because we are in a recession doesnt mean the market has come to a complete standstill. There are different ways you can invest which obviously vary depending on your current financial situation. There is an investment possibility for everyone, which can help put a little extra savings back in your pocket and even yield some future wealth down the road. Warren Buffet (1995), Anna Frago (2002), Kelley Wright (2010) stated that blue chip stocks are these companies hold leading positions in their industry and have a long, unbroken record of earnings growth and dividend payments. These stocks are high-grade, investment-quality issues of major companies that have the fundamental strength and size to hold their own during a recession and enough resources to capitalize on an economic recovery. Investors who are conservative and who seek safety and stability will usually invest in this group. In Malaysia, blue chip stocks include Public Bank, Genting, Sime Darby and others. Otherwise, investors typically add defensive stocks to their portfolios during economic recessions, or market downturn s. Thats because defensive stocks can be expected to perform relatively well during all phases of a business cycle even during difficult economic conditions as suggested by Warren Buffet (1995) Anna Farago (2002) Berba Velasco (2009), Esme Faerber (2008). A defensive stock is normally associated with a company that belongs to an industry or market sector that is unaffected by business cycles. That is to say, consumer demand for their products or services exists no matter how good or how bad the economy is performing. Defensive stocks are the opposite of cyclical stocks whereby the financial health of cyclical companies move in-sync with the health of the economy. Thats why these stocks are also referred to as non-cyclical stocks. Defensive stocks include companies belonging to the following market sectors are utilities, food beverages, healthcare, non-durable goods. The biggest advantage an investor gains through the purchase of defensive stock is a conservative portfolio that sh ould provide above average returns during a recession. The profitability of these stocks will hold up during these hard times because the demand for the products or services of these companies is relatively inelastic. Warren Buffet (1995), John Waggoner (2006), Esme Faerber (2008) also noted that investments in utility stocks are stocks of electric, water, gas, and telephone companies that are usually with a relatively decent dividend income and high degree of safety. Whether the economy is growing or slowing, people just need electricity, water, gas and phones, these services are an indispensable part of our lives. In Malaysia, there include Terlekom, Tenaga, Petronas and others. In the finding of Jim Roger (2007), Susan C.Walker (2008), Beth Anderson (2008), gold is traditionally seen as a safe investment, especially during a time of financial uncertainty, high inflation, depreciating exchange rates and economic recession. During a recession, gold is seen as a better investment than say the stock market. Stocks will fall as companies make less profit. David Prakash Egon von Greyerz (2009) also stated that gold is seen as a safe investment for preserving value of assets and has an intrinsic value. This encourages speculative buying of gold as investors diversify out of other riskier investments. Gold will also become attractive if we have negative real interest rates e.g. inflation higher than nominal interest rates. With negative real interest rates, saving in a bank becomes less attractive and gold become more attractive. Lavanay Bhadwal (2009) Julian D. W. Phillips (2010) also suggested that you can use gold as a short term or a long term investment where they will get sufficient returns. Research and analysis suggests that gold has grown by at least 2% in the last 50 years and the present decade has seen the gold market grow at 4% annually. During a recession, interest rates are typically at their lowest. This means that it will cost the average p erson less money in terms of interest payments to make large purchases. William H. Pivar (2004), Dold de Roos (2005) Sal S Vannutini (2008) suggested that among the largest of purchases is the purchase of a home of piece of investment real estate. As the demand for homes tends to decrease during a recession, sellers are forced to lower their asking prices in order to be more appealing to buyers. This lower asking price is also a monetary advantage to the individual looking to invest in a home or to buy a home and hold on to it long enough to have the market rebound and then sell that home for an easy profit. New home sales have seen a steady decline in value during the recession, but that is by no means the only indicator that those looking for an investment opportunity should use to base their decisions off of. Buying a new home that is currently undervalues simply because of the status of the market can be a brilliant investment move. According to Galen D. Burghardt, Terrence M. Belton, Morton Lane, John Papa (2005), corporate bond is a type of bond issued by a corporation. Corporate bonds often pay higher rates than government or municipal bonds, because they tend to be riskier as revealed by the bond holder receives interest payments (yield) and the principal is repaid on a fixed maturity date. US Treasury bond is a negotiable, coupon-bearing debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of more than 7 years. Interest is paid semi-annually at fixed coupon rate. U.S. Treasury Bonds are exempt from state and local taxes. These securities have the longest maturity of any bond issued by the U.S. Treasury, from 10 to 30 years. The 30-year bond is also called the long bond. These bonds are not callable, but some older U.S. Treasury Bonds available on the secondary market are callable within five years of the maturity date. In the finding of Esme Faerber (1999) Srichander Ramaswamy (2004), the prices of the long term US Treasury Bonds or the highest investment grade bonds would expect to increase during a recession because interest rates tend to fall during a recession. Corporate bonds for a bit more risk and pay out higher amounts but have just a little bit more risk than treasury bonds, especially during a recession. Bonds are considered to be less risky than stocks, since the company has to pay off all its debts (including bonds) before it handles its obligations to stockholders. Corporate bonds have a wide range of ratings and yields because the financial health of the issuers can vary widely. A high yield bond or junk bond is a bond that is rated below investment grade at the time of purchase. Edward I. Atman (1992), Matthew Goldstein (2001), Murali Ramaswami (1991) stated that bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors. Therefore, investors with a greater risk tolerance and much deeper pockets may even want to consider buying into a junk-bond fund. Recent history has shown that junk-bond investors have earned their best returns the year after the junk-bond market bottoms out. In 1991, while the nation was mired in its last recession, the junk-bond market produced an eye-popping 34.6% return on investment, according to Moodys. The impact of declining interest rates is magnified on the junk-bond market because high-yield bonds carry much higher rates than other kinds of bonds. Declining rates make those high yields that much more attractive, which tends to raise the price of the bonds that pay them. Gary L. Gastineau, David Lerman (2001) Archie M. Richard (2007) founded that an exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the FTSE Bursa Malaysia KLCI. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features. Investors can buying shares in several exchange-traded funds, or ETFs stocks that track the performance of a major market index such as the KLCI or the Mesdaq, or are based on actively managed mutual funds. That way, they can participate in any early rally in stocks without being overly exposed to any single companys poor earnings performance. ETFs have grown in popularity with individual investors because theyre cheaper and easier to invest in than traditional stock index funds during recession. Money market deposit account is a savings account which shares some of the characteristics of a money market fund. Like other savings accounts, money market deposit accounts are insured by the Federal government. They are very safe and highly liquid investments, but offer a lower interest ra te than most other investments as suggested by Marcia L. Stgum (1997) Julian Walmsley (2000). Credit default swap is a specific kind of counterparty agreement which allows the transfer of third party credit risk from one party to the other. One party in the swap is a lender and faces credit risk from a third party and the counterparty in the credit default swap agrees to insure this risk in exchange of regular periodic payments essentially an insurance premium. If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. In turn, the insurer pays the insured the remaining interest on the debt, as well as the principal. During recession, investors should keep some extra money in an interest-bearing money-market account especially if theyre investing money theyll need fairly soon. Matthew Goldstein (2001) also suggested that investors shouldnt expect to get rich off the 4% annual yields offered on most money-market accou nts but at least theyre guaranteed to make some money. Investors also stash some money in six-month or one-year bank certificates of deposit which on average pay a 2% higher annual yield than a money-market account. For the casual investor who does not have the time or inclination to actively manage his or her own portfolio. Graciela Kaminskyà ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¬Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚   Richard Lyons, Sergio Schmukler (2000) revealed that mutual funds reduce the time and effort needed and stays true even in a recession. The trick is finding mutual funds that do well in tough economic times. Madhu S. Panigrahi (1996), Esme Faerber (1999), Robert Kosowski (2006) Benz Jayma P. (2009) founded that are certain industries that weather recession better than others and the best mutual funds will be sector funds which are based on a specific industry. Industries that do well during economic downturn include utilities and staple consumer goods. Mutual funds in recession-proof sectors c an still be volatile and under-perform if the fund manager buys and sells constantly or the fund charges a high management fee. Review the fee structures for the funds you are considering and choose one with a high historical return and low fee. Other mutual funds that can be considered as recession proof would include money market funds and bond funds. The best way to use mutual funds both before and after a recession is to have a diversified mutual fund portfolio in the first place. Having a constructed portfolio of both stocks and bonds will provide you an opportunity or cushion for participating in stock market growth or markets decline. In conclusion, Warren Buffet (1995), Zvi Bodie Michael J.Clowes (2003), Stormy Brain (2008), Emanuel Balarie (2008) also concluded that recession offers many hidden opportunities and you need to seize them by understanding the basic rules on how to prosper in uncertain times. During this economic crisis, you can make some good long-term inv estments that will yield you fantastic returns in years to come. However, you should never put all your eggs in the same basket. Diversifying will help to protect your investments and will also give you great returns in good times or bad.