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Recessionary periods are inevitable. Now is as good a time as any to prepare to take advantage of the next recession. Here are three ways to do just that.
Key Takeaways
- As stock prices fall, use dollar-cost averaging to buy up shares while they’re cheap.
- Cushion losses with blue-chip dividend-paying stocks.
- One of the best ways to own dividend stocks is through mutual funds or exchange-traded funds (ETFs) that invest strictly in dividend-paying companies.
- Recession-proof your portfolio with consumer staples stocks, which weather recessions well.
1. Use Dollar-Cost Averaging
One of the first signs of a recession is usually a brief but sharp sell-off in the stock market. Then the real losses begin, but it’s important to note that the market will hit bottom and start back up well before the end of the recession.
Knowing that cycle, you can take advantage of a declining market through the dollar-cost averaging method of investing. If you make monthly contributions to a qualified retirement plan, you are already using the technique. But when the market starts to plunge, you might consider increasing your contributions to your retirement savings or build a stake in a separate investment account.
When you dollar-cost average, you reduce your overall cost basis over time. Then, when the price rebounds, your real profit will be higher.
For example, if you invest $500 a month in a mutual fund selling for $25, your contribution buys 20 shares. If the share price drops to $20, your contribution buys 25 shares. Your account now has 45 shares with an average cost basis of $22.
When share prices rebound, your contribution buys fewer shares each month, but the current share price will be higher than your cost basis.
Tip
The dollar-cost averaging method works well in any economic cycle for long-term investors who do not want to fret about how their investments are performing from day to day.
2. Buy Dividend-Paying Stocks
If you are going to hold stocks during a recessionary period, the best ones to own are usually from established, large-cap companies with strong balance sheets and cash flows. Not only are these companies better situated to weather economic downturns, they are more likely to pay shareholder dividends.
For investors, these stocks have three strong points. First, if a company has a long history of paying and increasing dividends, you can have peace of mind that it is financially sound and can survive most economic environments. Second, dividends provide a cushion. Even as share prices decline, you still get a return on your investment. Finally, dividend stocks tend to outperform non-dividend stocks during market downturns, because of those first two points.
The best way to own dividend stocks is typically through mutual funds or exchange-traded funds (ETFs) that invest strictly in dividend-paying companies. Funds that invest in companies with long histories of paying dividends and strong track records of increasing those dividends tend to generate high current yields and capital appreciation when the stock rebounds.
Funds that invest strictly in dividend-paying companies may not outperform the market during market rebounds. This is because they focus on companies that provide stable returns across market cycles.
As the market rebounds, you might move some money away from your dividend funds, but you should always maintain a portion in them as a defensive measure.
Important
The dividend-adjusted close, or adjusted closing price, takes into account any distributions or corporate actions that occurred between the previous day’s closing price and the next day’s opening price.
Dividends lower the value of a stock because some of its profits are distributed to shareholders rather than being invested back into the company.
3. Invest in Consumer Staples
Even during recessions, consumers need to buy food, drugs, hygiene products, and medical supplies. These are consumer staples, which are the last items to be cut from the family budget.
So while companies selling high-end electronics and other discretionary products experience a decline in revenue, companies selling food products and other necessities do not. Because of this, companies in the consumer staples sector are sometimes called defensive stocks, since they tend to remain resilient even when the economy falters.
Data shows that these types of companies outperformed the S&P 500 during the last several recessionary periods.
Consumer staple companies include Johnson & Johnson, Procter & Gamble, Conagra, and Walmart. These companies also pay good dividends, which strengthens their defensive profile.
There are mutual funds that invest strictly in consumer staple companies. For example, the Fidelity Select Consumer Staples Portfolio invests a minimum of 80% of its assets in companies engaged in the manufacture, sale, or distribution of consumer staples.
What Investments Do Well in a Recession?
Defensive stocks, such as those in the consumer staples sector, tend to be resilient during recessionary periods. They make and sell products that consumers want and need, not products they put off buying when times are hard. Other strong options include discount retailers and funeral service providers.
What Should I Not Do During a Recession?
Where Is My Money Safest During a Recession?
During recessionary periods, many investors turn to the most conservative asset classes, such as high-quality bonds, Treasury notes, and cash savings. For a little more risk, stick with large-cap companies with strong balance sheets and cash flow. Or, put your money in one of the many mutual funds that focus on these blue-chip investments.
The Bottom Line
While recessions are inevitable, their onset and duration are usually unpredictable. But there are ways to position yourself and your investments to weather the storm and even profit from it.
