As average consumers, it’s not uncommon for us to look for ways to put more money in our pockets. After all, we are all on the journey to financial freedom. While we all know that it’s important to invest, we tend to just go with what our advisor tells us to do. However, did you know that you can use what’s known as the economic cycle to improve your returns on your investments?
What Is The Economic Cycle?
The economic cycle, in the most basic of explanations is the cycle in which the economy moves and the market follows. Ultimately, there are four key points in the economic cycle. These include:
- Market Bottom/Full Recession – The first point in this cycle is known as the market bottom or full recession. It is at this point that the stock market reaches its lowest level.
- Bull Market/Recovering Economy – After reaching the bottom, we tend to see what is known as the bull market or economic recovery. During this time, economic conditions start to improve, increasing investor faith in the market. As a result, we tend to see a series of higher highs and higher lows as the market fluctuates in value.
- Market Top – At the market top, the market is filled with high expectations, but production plateaus. This is the highest point we tend to see in the market before a bear market ensues.
- Bear Market/Falling Economy – Finally, we have the bear market that is coupled with poor economic conditions that continue to fall toward a correction. The bear market is characterized by a series of lower highs and lower lows as the market sees fluctuations in value.
Using The Economic Cycle To Your Advantage
The economic cycle isn’t just something that we can study, it’s something that we can use to our advantage when investing. At the end of the day, the cycle represents signals as to when it’s time to rebalance a portfolio and what risks are worth considering. Here’s how it works:
- Market Bottom/Full Recession – During the market bottom portion of the cycle, it’s best to balance your portfolio for low risk. Instead of focusing on the potential to make a higher return in the stock market, it’s best to consider looking into safe haven investments. However, be careful with bonds in these times as this is when the Federal Reserve tends to reduce rates, leading to dwindling returns on bonds and other similar investments.
- Bull Market/Recovering Economy – During the bull market, it’s time to ditch the safe havens. Selling them as the bull market begins will likely give you the best returns. From there, balance your portfolio to include a high portion of your available funds in the stock market and a small portion of your available funds in safe haven investments.
- Market Top – Warren Buffett once said that it’s time to buy when fear is high and sell when the greed is high. The market top is the point at which greed is highest. However, this is the point that is followed by a bear market, so starting to rebalance toward a lower risk investment portfolio is best.
- Bear Market/Falling Economy – The beginning of the bear market is the best time to rebalance your portfolio toward a low risk strategy. The idea here is to move back toward safe havens and reduce your exposure to the stock market. As the economy declines, you’ll see a series of lower lows and higher highs. While many will ride these lows out, by rebalancing toward safe haven investments, you’ll start the bull market on much stronger footing after the market bottom.
While most of us know that investing is important, the intricacies of investing can be a bit daunting. Nonetheless, by following the economic cycle, and taking advantage of the signals it provides, you have the potential to expand your earnings not only in the bull market, but also during the bear market.