A crucial part of investing is being prepared for the inevitable ebbs and flows of the economy. As a wise investor, you may find yourself worrying about how the next recession could negatively impact your investment portfolios.
For peace of mind, take some steps now to prepare your portfolio, and your mettle, for the next fluctuation in the market. Here are some ways to prepare your investment portfolio for a recession.
What Is a Recession?
Recessions are extended periods of significant economic decline. This can take many forms, so a recession is typically defined as two consecutive quarters with negative gross domestic product (GDP) growth. The GDP is the total of goods and services produced in a period of time.
The effects of a recession may be felt across the economy and lead to reduced consumer and business confidence. As a result, unemployment often rises as sales and production diminish across multiple industries.
The stock market inevitably reacts to this change in the economic mood and prices and the overall stock forecast fall. This culmination usually leads investors to act with more risk aversion in an attempt to protect their assets.
When to Expect Another Recession
According to the National Bureau of Economic Research, we have had at least one recession every ten years since 1858. Since the last recession ended in June of 2009, the United States is due for another one soon.
For many Millennial investors, recession means an event like the Great Recession of the late 2000s that shaped their young adult years. In reality, most recessions are not that devastating, so it stands out among the worst recessions in the country’s history.
Historically, the market makes a full recovery after a recession and goes on to grow and perform well.
Creating a Recession-Proof Investment Strategy
Developing a recession-proof investment portfolio can happen in anticipation of a recession prior to poor economic performance. And, even if you didn’t act in advance, you can still take many of the following steps if a recession has already started.
Preparing for a recession simply requires diversification, creating an emergency fund, and maintaining a steady head when prices start to drop.
Avoid a Sell-Off
Investors experiencing their first recession may wish to sell investments in a knee-jerk attempt to avoid a bigger loss after being shaken by market falls. This period when the recession becomes widely recognized and sell-offs occur is the most dangerous time for investors, especially new ones.
Ultimately, selling during market lows should be avoided at all costs. It simply finalizes losses and eliminates the possibility of recovery. Instead, those who hold on to their investments go on to recoup their money when the market recovers.
The best way to avoid selling when the market is low is to have a separate, robust emergency fund either outside your investment portfolio or in an exceedingly low-risk, liquid investment, like U.S. Treasury securities.
This way, if a medical emergency or job loss occurs during the recession, there will be no need to cash out at a loss. Financial planners recommend establishing an emergency fund that could support a household for at least six months without income.
While establishing an emergency fund can delay creating enough capital for big investments, that emergency fund can ultimately save your investments in worst-case scenario situations that would otherwise cause you to sell at a loss.
Remember Previous Market Falls
A good way to gauge how a recession will impact you and your portfolio is by remembering previous instances of market shifts. Consider the early days of the coronavirus pandemic and the initial dive in the market. Were you feeling panic and fear of financial ruin? If so, a more conservative investment approach may be more appropriate for you.
Use the Dip to Your Advantage
For those in a position to do so, buying during an economic downturn can be the investing equivalent of Black Friday shopping. It can be an opportunity to get a few aspirational stocks that you wouldn’t usually splurge on with the hopes they return to their pre-recession levels and continue to perform well.
Diversification Is the Best Protection
Many portfolios need no particular recession proofing because they were created with care and attention to the best recession medicine: diversification.
Diversification is always ideal, but it becomes essential during recessions. True portfolio diversification requires multiple types of investments focused on a variety of industries and markets. After all, a recession does not impact every place equally.
Portfolio diversification doesn’t guarantee that your portfolio will retain all its value in the event of a recession, but it reduces the likelihood that every single asset will decline in value. Ideally, some of the assets will benefit during the downturn and help make up for value lost elsewhere.
The pandemic provides an easy example of how crucial diversification is during recessions. The travel industry experienced major losses and stocks plummeted. But, as people stayed at and worked from home, the technology sector performed better than ever.
Fixed-income investments are a perennial favorite for investors concerned about an imminent recession. Fixed-income investments are those that pay a fixed interest rate or dividends until the maturity date. Then, at maturity, investors receive their principal amount back.
Government and corporate bonds are the most common sources of fixed-income investments. However, as investors seek the safety of fixed-income investments, expect the bond prices to increase and, therefore, the yields to decrease.
Some investors prepare for recessions with the thought that the economic woes will not spread across the globe, so they turn to commodities investing.
Commodities are essential goods, like oil and grains, forming the building blocks of other goods and services.
Commodity demand increases with economic output. They are traded on a global scale rather than national. So, reduced economic activity in the United States may not impact commodities if other foreign economies are thriving.
Look for Recession-Proof Stocks
Investors can turn to stocks and other investments considered recession-proof in the quest toward diversification. Whether a specific company or industry is recession-proof often becomes a trending topic and makes it hard to separate buzz from reality, but common sense can steer you in the right direction.
Think about your own lifestyle and the things you will keep buying, even if times get hard or you experience a reduction in income – what matters most?
The majority of us would choose to keep the lights on and water running as long as we had some money left in the bank, making utilities a reliable investment. Many ETFs and mutual funds exist that center on utility companies.
Or, as we learned in March 2020, personal paper products have a strong pull on the American consumer. While no ETF dedicated to the toilet paper industry exists, many consumer staples funds are out there. They are characterized by slow, steady growth and a lack of volatility.
While the Great Recession created a cautionary tale for investors, it is important to remember that few recessions are as lengthy or dramatic. Removing the fear from recessions enables us to better prepare for them and prevent them from being as devastating.
In preparation, remember that diversification is an important, proactive step to take and many investors use it as their central strategy regardless of fears of an upcoming recession.
However, the single most important thing that any investor can do is establish an emergency fund sufficient to cover living expenses for at least six months. Then, if you have no need to dip into your investment portfolio, you can weather any storm that arises until the economy begins to recover.If you are looking for the next opportunity to diversify and grow your portfolio, Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income, giving them greater peace of mind to weather any economic downturn. Learn more about our passive income strategy.