According to the pros, a recession is on its way. In a recent Bloomberg article, reports from leading experts at both multinational organizations Deutsche Bank and Citi Bank forecast the likelihood of a global recession at above 50%. Leaders of both organizations cited global supply chain issues causing inflation to spike to a 40-year high of 9.1%.
The federal government’s response to the record-breaking inflation is to raise interest rates. While this is common during times of high inflation, it can slow consumer spending, which might be one of the triggers for a recession.
But just because a recession might be on the horizon doesn’t mean it’s time to dump your positions and hide your money under a mattress. In fact — that might be one of the worst things you could do. Here is a guide to recessions and how to prepare your finances and investments to withstand the downturn.
The Short Version
- Recessions are a normal part of the economic cycle — no need to panic.
- During periods of economic contraction, investors should prioritize portfolio diversification, including recession proof-industries like healthcare and consumer products.
- Don’t ditch your bonds and avoid panic-selling.
- Shore up your cash reserves so you don't have to dip into your investment portfolio if you experience a reduction in income.
In This Article
What Is a Recession?
The simplest definition of a recession is when the economy stops growing and starts to shrink. A more in-depth explanation of a recession depends on who you ask.
Some define a recession as when the U.S. economy’s gross domestic product (GDP), which is the value of goods and services produced, declines for two consecutive quarters. The National Bureau of Economic Research describes a recession as a “significant decline in economic activity” lasting for several months.
While there are a variety of definitions of what constitutes a recession, it’s clear that the U.S. economy is on the verge of one — if not already in one.
A Recession Doesn’t Mean It’s Time To Panic-Sell
With a possible recession on our doorsteps, is it time to panic, sell all of your stocks, and start hoarding cash?
The answer is a resounding “no.” Now is not the time to panic. While we’re living in unprecedented times, recessions are not new, and we know what to expect.
Fortunately, we have a lot of data about recessions: the U.S. has seen 13 since the Great Depression. We know how they tend to act and what to do when one hits.
How To Prepare Your Portfolio for a Recession
So how should you change your investment strategy during a recession? We’ve outlined steps you should (and shouldn’t take) to prepare your investment portfolio for a recession.
1. Diversify Your Portfolio
While you should continuously diversify your well-balanced portfolio, it’s even more crucial during a market decline. Holding a wide variety of securities across asset classes and geographic areas can help insulate your portfolio against downturns.
An easy way to diversify quickly is to buy index funds instead of individual stocks. This way, your portfolio won't decrease dramatically if one of the stocks within the fund fails — you still have all the other stocks in the index.
Read more >>> How to Invest in Index Funds: Do It Right
2. Choose Securities That Perform Well During Recessions
If you own individual stocks instead of indexes or ETFs, now is an excellent time to review your holdings and consider making changes. For example, if your portfolio is heavy on growth stocks (stocks that provide above-average returns), consider adjusting your allocation to focus more on value or dividend stocks, which tend to perform better during a recession.
Make sure to do your due diligence on the stocks you choose, especially if you select a value ETF. Value ETFs can often include distressed or low-quality companies in these portfolios, which are particularly susceptible to insolvency during a recession.
3. Don’t Eschew Bonds
Bonds are another essential part of your recession-resistant portfolio. While bonds typically move in the opposite direction of interest rate hikes, they still have value in a recession. You might be tempted to shed your portfolio’s bonds, which have lost value, but that move would be short-sighted.
Bond values will recover in the future when interest rates start to drop. This can offset some of your stock losses. You get the most out of your bonds when you hold them for the long term, so now is not the time to dump them.
Read more >>> How to Invest in Bonds: Diversify Your Portfolio
4. Prioritize Recession-Proof Industries
If you want to tweak your portfolio (although we don’t generally advise that, more below), you should consider prioritizing recession-proof industries. For example, healthcare and senior living companies usually stay relatively stable during a recession.
In addition, companies that sell essential consumer products tend to weather recessions quite well. You can choose to invest in individual companies like Proctor & Gamble or in ETFs or REITs to give your portfolio broader exposure.
5. Consider Increasing Your Cash Reserves
Finally, while preparing your investments to weather a recession is important, you shouldn’t neglect the cash reserve aspect of your financial portfolio. After all, the best place for your portfolio right now is in the market. If you're laid off, the last thing you want is to withdraw funds from your investments because of inadequate cash reserves. As a starting point, you should aim to save three months of expenses in cash, but six months or more is not unreasonable.
Bonus Tip: If You Don’t Know What To Do, Do Nothing
While there are some steps you can take to protect your investments during a recession, leaving your portfolio alone may actually the best option if you aren’t sure what to do.
Yes, the stock market is falling, and it’s difficult to watch your investment portfolio shrink. But keep in mind that recessions are normal and part of the stock market's boom-bust cycle.
Financial advisors and robo-advisors factor these fluctuations into their planning, so you shouldn’t have to tinker with your portfolio during a recession. In fact, actively managing your portfolio to avoid declines during a recession might result in worse returns over time.
Read more>>>Best Robo-Advisors for 2022
The Bottom Line
Recessions can be scary, but investing during one isn’t that different from investing in any other market. You can tweak your portfolio to focus on asset classes that perform better. Still, generally speaking, a diversified portfolio is designed to weather the ups and downs of the market. While it can be difficult to stomach losses in the short term, holding onto your investments is necessary to achieve long-term success.
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- Top Long-Term Investment Strategies to Use in 2022
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