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Though recessions can be tough on investment portfolios, it’s important to remember that they don’t last forever. Most asset prices tend to recover and continue their upward trajectory once the economy is back on track again.
Still, there are things you can do to prepare your portfolio for an economic shock. Here are four ways to help set your mind at rest and be covered for all scenarios.
Key Takeaways
- Defensive stocks are built to withstand a recession. Many offer decent dividends that can add up over time.
- Recessions serve as a reminder of the importance of owning various investments across different asset classes and regions of the world.
- Dollar-cost averaging can pay off during an economic downturn by reducing the average purchase price.
- If you have built a well-balanced portfolio, stick by it and don’t check it every day to see how much it is losing.
1. Invest in Quality, Cash-Rich Defensive Stocks
Some businesses tend to struggle during a recession, while others are better built to withstand them.
Stocks are generally placed in one of two categories: cyclical or defensive. Cyclical stocks are sensitive to the health of the economy, excelling when there is growth and struggling when everything slows down. Defensive stocks, on the other hand, offer stability through all phases of the business cycle.
How do they achieve that? By being well-run, possessing strong pricing power, and supplying products that consumers either cannot or do not want to live without, such as water, electricity, food, and essential household products like toilet paper.
Defensive companies, which are mainly associated with the consumer staples and utilities sectors, are good to own. Other than being less volatile and sensitive to economic downturns, they also tend to generate lots of cash and pay decent dividends.
Income investments, in general, are an important component of a well-rounded, balanced portfolio and add significant value over the years when dividend proceeds are reinvested. Dividends can also offer a nice cushion against stock price depreciation, provided the balance sheet doesn’t become too stretched and there’s enough money to continue to fund them.
During recessions, you want to own high-quality assets that keep making money, generate lots of cash, and have robust balance sheets. Avoid companies with lots of debt as a slowdown in revenues and changing credit conditions could spell trouble for them.
2. Diversify: Don’t Put All Your Eggs in One Basket
When the economy is booming, holding growth stocks can really pay off. But these types of companies are likely to perform poorly when growth in the economy slows or turns negative. When there’s a recession, investors can begin to appreciate diversification by owning investments across different asset classes.
To build a portfolio truly capable of weathering any type of situation, you ideally need to add some government and investment-grade corporate bonds, money market instruments, and maybe even gold. That’s especially the case when you’re nearing retirement or need the money you’ve invested soon.
Each asset class tends to behave differently. For example, historically, while stocks have done well when the economy is expanding, bonds often do well during recessions. This inverse relationship means the two can complement each other and essentially ensure that no matter the economic climate, at least part of your investment portfolio will grow in value—or not get completely clobbered.
International exposure is also important. While the economies of the world’s nations are increasingly interlinked, there can be exceptions and regions offering slightly better growth prospects at any given moment.
If you don’t feel comfortable building a well-balanced, diversified portfolio, consider enlisting the help of a financial advisor or an asset manager.
3. Try Dollar-Cost Averaging
Recessions present a great opportunity to profit from dollar-cost averaging, which is the process of buying investments at regular intervals, such as when you get paid. Consider setting up a system that will do this for you automatically.
This strategy makes the purchase price less essential and reduces the importance of getting the timing right. It also means that you can profit from a recession by buying shares or assets at lower prices. Many investors make the mistake of buying high and selling low. With dollar-cost averaging, it’s all automatic and you get the chance to top up holdings when they are at their most undesirable and cheapest.
One common complaint is that regular buying restricts potential upside when markets are trending upwards. Others would say that’s a fair price to pay for the option of spreading out payments and limiting volatility.
4. Stick to the Plan and Don’t Panic
The above tips can help you build a portfolio to weather any storm. Beyond that, the best piece of advice on how to protect yourself against a recession is to not panic.
Many great investors say that when the market is in a downtown, don’t check your portfolio on a regular basis. This is because it can be tempting to cut your losses and exit your positions. Instead, they say, you should stay the course, especially if you built your portfolio for the long-term.
Long-term, buy-and-hold investors should stick to their guns and not let short-term market noise push them off course.
During a recession, it might all seem doom and gloom. But if you look at the performance of the S&P 500 over time, you’ll see that it moves up, and occasionally dips, and then moves up even higher than before.
Long-term investing is a marathon, not a sprint. Think carefully about how to build a well-balanced portfolio, get advice when needed, and then once you’ve settled on how you want to invest, sit back, be patient, and stand by your plan.
What Stocks Do Well During Recessions?
It’s very rare for individual share prices to rise during a huge market sell-off. However, there are companies that tend to shed less value and perform better than others. They generally have pricing power and limited competitive pressures. These include utilities and consumer staples companies that supply the population with goods and services that people can’t live without.
What Falls Most in a Recession?
Highly cyclical industries and companies with lots of debt suffer more than others during a recession. Sectors that can be hit more severely include real estate, restaurants, hotel chains, and airlines. When money is in short supply and people are scared to spend, demand for these types of non-essential goods and services tends to dry up.
What Should I Do During a Recession?
Outside of investing, it generally pays to be more prudent with spending and prepare yourself for the reality that you could lose your job. Put as much money aside as possible and try to avoid selling your long-term investments.
The Bottom Line
Unfortunately, recessions are an inevitable part of the business cycle. It’s importantly to be prepared for any scenario as things can quickly and unexpectedly go south, as we saw, for example, in 2020 (briefly) and in 2007-2009. You can minimize the damage by investing in quality defensive stocks, diversifying, using dollar-cost averaging, and not panicking.
