What is Recession? (Plain English Definition)
Definition: A recession is a significant decline in economic activity lasting more than a few months, typically defined as two consecutive quarters of declining GDP.
Recession Explained Simply
A recession is a substantial and prolonged downturn in economic activity. While the common shorthand is two consecutive quarters of declining GDP, the official determination in the U.S. is made by the National Bureau of Economic Research (NBER) based on a broader set of indicators including employment, income, production, and sales.
Recessions are a normal part of the economic cycle. Since World War II, the U.S. has experienced about 12 recessions, roughly one every 6-7 years. They vary in severity -- the 2001 recession was relatively mild (8 months), while the 2007-2009 Great Recession was severe (18 months) and the 2020 COVID recession was deep but brief (2 months).
During recessions, corporate earnings typically decline, unemployment rises, consumer spending falls, and stock prices usually drop. However, recessions are temporary. The economy has always recovered and eventually reached new highs. For long-term investors, recessions create buying opportunities as stock prices become depressed relative to long-term earning power.
Recession Example
During the 2007-2009 recession, the S&P 500 fell about 57% from peak to trough. An investor with $100,000 saw their portfolio drop to about $43,000 -- a terrifying decline. But investors who stayed the course and kept buying saw the market recover its losses by 2013 and go on to triple over the next decade. The recession created an exceptional buying opportunity for those with the courage to invest during the downturn.
Why Recession Matters for ETF Investors
Recessions test ETF investors' emotional discipline more than any other market event. The temptation to sell everything and retreat to cash is strongest during recessions, but this is usually the worst possible time to sell. Historically, the best buying opportunities occur during recessions when fear is highest and prices are lowest. For ETF investors, the best recession strategy is to continue investing through your regular dollar-cost averaging program. Having a well-diversified portfolio with appropriate bond allocation helps cushion the blow. Remember that recessions are temporary -- every one in U.S. history has been followed by a recovery. Your investment time horizon is almost certainly longer than any recession.
Recession vs Bear Market
| Recession | Bear Market |
|---|---|
| A recession is a significant decline in economic activity lasting more than a few months, typically defined as two consecutive quarters of declining GDP. | See full definition of Bear Market |
While recession and bear market are related concepts, they serve different purposes in the world of ETF investing. Understanding both terms helps you make more informed decisions about which funds to include in your portfolio and how to evaluate their performance.
Related Terms
Deepen your understanding of ETF investing by exploring these related concepts:
Bear Market
A bear market is a prolonged decline in stock prices, typically defined as a drop of 20% or more from recent highs.
Gross Domestic Product (GDP)
Gross domestic product is the total value of all goods and services produced within a country during a specific time period, measuring the size of an economy.
Bull Market
A bull market is an extended period of rising stock prices, typically defined as a gain of 20% or more from recent lows.
Dollar Cost Averaging (DCA)
Dollar cost averaging is the strategy of investing a fixed amount of money at regular intervals regardless of market conditions.
Diversification
Diversification is the strategy of spreading investments across different assets to reduce risk, based on the principle of not putting all your eggs in one basket.
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