Nowadays the conversation is about whether or not there’s still even a possibility of being able to build wealth at all, let alone how to build wealth in a recession.
With the talk starting to mount that the United States is in, or presumably at least heading into a recession, the tenor of the conversation has shifted. Whereas over the past several years of what was a pretty solid and favorable economy, the discussion was more or less focused on which strategy or investment was going to build your wealth the fastest.
The approach in a Recession is the same
Strangely enough, and there’s not going to be much of a surprise to regular readers on this site, the approach to building wealth in a recession is not a whole lot different than building wealth in a great economy! That said, there may be an approach or two that might be better at this moment than another because of some dynamics that we will discuss herein but by in large, the approaches are about the same.
Let’s talk about the 800-pound gorilla that’s in the room in order to get it out of the way. Yes it would seem that the equity markets are in a challenging position at this current time, evidenced by the S&P 500 having a negative 14 % year to date total return.
Therefore, one could reasonably conclude that if they were contemplating whether they could build wealth at this point in time in the short term by investing in a broader equity index such as the S&P 500 the answer would probably be an understandable ‘NO’.
However, that could change going forward…but for now at this moment in time it is true that a broader equity index such as the S&P 500 is in negative territory year to date.
Is there a better strategy?
So what other strategy might be readily available that would be better to build wealth? Could it be real estate? Well, there are some areas of real estate due to the fact that it is regional and tends to have separate performance aspects (commercial, residential, multi-unit housing, etc.) that makes it an interesting strategy during a recession.
However, what is making real estate a bit more challenging at this point in time is the increase in the cost to own real estate, set forward by an increase in the primary interest rate by the Federal Reserve to an upward range of 2.5%, as well as the expense to build housing due to challenged supply lines and lack of production for some materials.
This makes the purchase of a real estate asset more expensive against the backdrop of what rents are at and capable of generating for revenue.
From a financial perspective, when the cost to borrow money increases the amount of profit that can be generated is usually diminished because the gap between revenue and expenses becomes smaller. This in turn reduces the overall potential return on investment and although not negative like the S&P 500 currently is to date, it raises caution from wealth builders as to whether this is the best approach to building wealth.
What makes sense in a Recession?
So if not equities nor real estate assets, is there a wealth building approach that makes sense in a recession? Well, just like it usually makes sense no matter what the economy is doing (except in severe economic crises) starting a business is always the most favorable asset class to create.
Although there are many great reasons to start a business, especially in times of a recession one of the most compelling reasons is that the person starting the business is in control of their capital.
Starting a business allows the entrepreneur to put their resources, both time and money in particular, where they believe will result in the highest returns.
In addition, in many cases businesses tend to enjoy a high margin which translates into a respectable cash on cash return that is exceedingly hard for the other asset classes (equities/bonds and real estate) to compete with.
The one disadvantage against the other asset classes is that businesses are an active asset that must be worked, whereas equities and bonds are truly a passive investment.
A Business is ALWAYS a compelling wealth building asset
That said with a high cash on cash return possibility and ability to efficiently deploy capital, a business is a very compelling venture in all times and particularly when the other asset classes are challenged to even be in the positive return territory. In addition, recessions tend to create opportunities due to the fact that people tend to become challenged in ways that they weren’t before and are looking for either different solutions or more effective ones.
In many circumstances during a recession people are looking for ways to reduce the time and or stress involved in conducting routine tasks or activities that they are not necessarily passionate about. As such, there is a substantial amount of niches that can be focused on with very little capital to start a business.
Whether the opportunity is presented due to tough times or not, creating a business has to be looked at as not only a hedge against inflation but also a wealth accelerator. It’s one of the only opportunities where someone can take as little as several hundred dollars and parlay it into millions of dollars.
Summary
Even if a business venture doesn’t reach that level of financial success it is highly plausible that a business could sell for more than three times gross sales beyond the margin of profit enjoyed while the founder owns it. This is the inherent leverage available in a business asset.
Recessions present challenges. They also present opportunities. The creation of a business provides the wealth builder with the chance to take these challenges and turn them into opportunities, all by making a profit while doing it!
Sounds like a recession-proof plan to me.
