Recessions happen. It’s the unfortunate reality in which we live: sometimes, events beyond our control tank the economy. During a recession, we run around like chickens with our heads cut off fretting about the state of our investments. Afterward, we are left to scramble to pick up the pieces.
The shutdown economy and pandemic markets of 2020 are a perfect example of an unexpected event that shattered world economies. Before that, it was the Great Recession; the unfortunate byproduct of too-generous banks and a massive housing bubble.
While these events aren’t incredibly common, they show why we should be concerned about the implications of the next recession. And, when the next recession comes, you’ll want to know how to invest wisely before, during, and even after to bolster your portfolio and hedge against gigantic losses.
Before we continue, Financial Professional wants to remind you that this article is educational in nature. Any securities or firms named are for illustrative purposes only and do not constitute financial advice. Always do your due diligence and consider your situation – and the help of a licensed financial professional – when making investment decisions.
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Accept that Recessions Happen
The first thing to know about investing during a recession is just that they happen. There’s nothing any one person (or even one country) can do about it. In fact, in some regards, a recession can be healthy – within reason.
For instance, they are a “natural” way to correct an economy or the actions of certain entities (looking at you, 2008). Furthermore, while the events of 2020 are something of an anomaly, no one can deny that the pandemic has forever changed the way we view working in the modern age.
Typically, though, recessions occur in less bombastic settings. Capitalist economies normally work in cycles: they expand, peak, contract (go into recession), bottom out, and expand once more. This natural evolution of capitalist economies means that recessions are inherently built into the framework.
There are several reasons a recession may come about. For instance, a tiny germ may spread around the world and cause governments to order citizens indoors and businesses shuttered. Alternatively, banks may loan money to individuals who can’t financially afford the terms but are legally qualified to sign the contracts, thus resulting in the ripple felt ’round the world.
In less causal terms, though, an economy usually goes into a recession when it reaches capacity. In fact, the Federal Reserve has been known to induce recessions via monetary policy to quell an overheating economy. While this action may seem counterproductive, in fact, it promotes the overall stability and health of a country’s finances.
Capitalize on the Downturn
The next thing to know about investing during a recession is that it’s possible to capitalize on new opportunities. One of the quickest ways to get rich off economic downturn is to acquire new assets at steeply discounted prices. This is one of the times where the old adage “buy low, sell high” proves easiest to oblige – so long as you make the right calls.
Know Why You Invest
During a recession more than ever, it’s imperative to understand why you’re investing. Keeping your financial goals in mind provides you with clarity and context for your future – and even your now. Consider if you’re:
- Creating a fixed or secondary income
- Minimizing risk and volatility
- Maximizing long-term returns
- Capitalizing on the economic downturn
- Investing for retirement
- Funding your child’s education
- Buying a house
It’s possible to prepare your portfolio before and during a recession to suit all of these goals. At the same time, earning enough to satisfy even one goal allows you to set it aside and get started on the next. Knowing what (and by when) you’re trying to accomplish allows you to adjust your expectations during a recession.
You should also consider your age and risk tolerance when you invest, regardless of how the economy is performing. Younger investors are unlikely to feel the same negative impacts of a recession as older investors due to an increased risk tolerance.
That being said, every person’s situation is different, and everyone has a risk tolerance adjusted toward their lives and lifestyles. Only you (and perhaps your financial advisor) know what is best for you. That’s why it’s important to take time to review your financial goals before you start investing willy-nilly during a recession.
Maintain Your Emergency Savings Fund
While this may not directly relate to your investment portfolio, an emergency savings fund may save your life (or at least your way of living) during a recession. Most financial experts agree that an emergency savings fund should contain at least 3-6 months’ worth of expenses. For those in their 50s and 60s, it may be wise to have closer to a full years’ worth tucked away.
As the name indicates, an emergency savings fund should only be touched in the event of emergency or financial hardship. And, if possible, you shouldn’t stop stashing these funds away during a recession, even if you have to reduce your monthly contributions. It’s always best to be proactive with your personal finances and investments, and that’s exactly what you’re doing by keeping your emergency account intact.
Keep Your Wits About You
Buying low and selling high is easier said than done. However, when an index such as the S&P 500 swoops downward so fast you get whiplash, that’s exactly what you’re doing. Long term investors essentially consider these downturns as stocks going on sale.
Importantly, though, you have to keep your wits about you to make this mindset (and investing strategy) work during a recession.
During periods of recession, investors often let their emotions take over – primarily worry that they’re going to lose all their money. This causes many individuals to sell positions in a panic, often at a steep loss. Risky assets such as stocks (equities) typically go first as investors flock to “safer” assets such as bonds or cash. All of this downward pressure on the stock prices creates rich opportunities for discounts…as long as you’re not on the selling end.
What’s the Point?
While this seems obvious in hindsight, during a recession, logic and foresight isn’t so clear to a panicking investing market. This, along with skittish nerves, is what makes buying low, selling high, and holding golden opportunities throughout hard times so difficult. Many investors do actually buy the dip to start – and then abandon their strategy when the markets fall again.
It’s important to note that recessions vary in length and severity. No one knows a recession is over until hindsight kicks in and the economy is growing once more. A long-term perspective, patience, and a higher emotional tolerance to paper losses are the key to weathering and capitalizing on recession.
How to Invest During a Recession
There are a few ways to invest during a recession, but it all comes down to your current circumstances and goals. If you’re able to take aggressive bets, you have the chance to maximize your potential at the sake of increased risk. However, if you just want a little money on the side to boost a lagging income, you’ll want to look at safer investments, which may cost you some interest.
First Thing’s First: Diversify Your Investments
Diversification may limit returns, but it can also save your portfolio and hedge against losses. This is what makes the prospect attractive (and a good idea). The point of diversification is the minimize the impacts of steep losses from any one security or sector – such as during a recession.
A diversified portfolio is merely a portfolio that has different parts moving in different directions across time. While investing in a diversified portfolio won’t make you invincible, it can help spread risk during a recession. For instance, fixed income and cash equivalents tend to be less risky than equities. If you’re looking for something a little higher in value, gold and real estate may also reduce the effect of volatility on your investments.
Furthermore, while some recessions are domestic in nature, they can also be global. Since there’s no way to predict when or how a recession will absolutely occur, it might be a good idea to diversify across countries as well as asset classes and sectors.
To that end, if you’re looking to diversify during a recession, consider investing across:
- Asset classes
- Market capitalizations
- Types of funds
Consider Sectors that Perform During Recessions
Some sectors perform better than others during a recession, depending on why the recession came about. As a rule, healthcare and consumer staples tend to give consistent or high returns in a recession due to the constant demand. Eventually, you’re going to have to eat, go pee, and see the doctor – and these companies know that.
The 2020 pandemic market is a unique situation because the recession occurred as a result of a global disease outbreak. As a result, many companies in the medical sector – such as hospitals, research labs, and pharmaceutical companies – experienced much larger than normal growth throughout the year. Whereas indices such as the S&P 500 hovered around 10% down for months on end, the healthcare sector rose to 4.6% up year-to-date by mid-August.
Technology is another area that jumped uniquely as a result of the pandemic market. Worldwide lockdowns and quarantines forced millions to work, play, and connect entirely from their living rooms. This led to massive spikes in technology purchases and technological funding to develop or improve work-from-home solutions.
If you want to buy into a sector that doesn’t usually perform during a recession, but seems to this time around, consult with your financial advisor about the benefits and risks. Some sectors may perform temporarily, only to fall once more, while others may continue to outperform their competitors and the market at large. Since investing is essentially a bet on a security’s performance, you’re playing with real money – and there’s little worse than losing everything on a bad bet.
Defend Your Positions
In investing, there’s a significant difference between a defensive stock and one that’s experiencing a cyclical uptick. Knowing the distinction may save your portfolio in a pinch.
Cyclical stocks follow the business cycle, which means they perform in good times and suffer when the tide turns. Airlines are a classic example of a cyclical stock; when recessions hit, people have less disposable income. This comes back to bite airlines in the profits.
The 2020 pandemic market offered a unique glimpse of what happens when a cyclical stock enters its worst-case scenario. In the case of airlines, not only were millions pushed out of their jobs, but travel restrictions made it nearly impossible to book a flight. Then, once the hubbub died down, few were willing to risk traveling in a flying cesspool. This led to one of the worst downturns the airline industry has ever seen: stocks dropped so far that legendary investor Warren Buffet shed his long-term airline investments.
Defensive stocks, on the other hand, are companies that offer mainstay products and services. These stocks typically come from the sectors that perform well (or at least hurt less) during a recession. Consumer staples such as toiletries, groceries, and even tobacco fall under the defensive stock umbrella.
While this is unique to the most recent pandemic and recession, technology stocks also became a defensive position in 2020. Companies such as Amazon, Facebook, Apple, and Microsoft all exceeded expectations; in some cases, they even outperformed pre-pandemic predictions, despite the economy at large suffering.
If you’re looking to start investing in a recession market, consider defensive stocks first. And remember: what’s defensive may change depending on the circumstances. Be prepared to think outside the box (and consult your financial advisor before you bet).
Stick with Healthy Companies
As we mentioned, different investments react to economic instability in different ways. For instance, technology and online entertainment stocks soared throughout 2020. This was the result of increased demand in addition to several savvy business moves. On the other hand, airlines famously tanked on several occasions in 2020 as the bad news punches kept on coming.
Therefore, if you’re looking to invest during a recession but you’re not sure where to look, consider healthy, quality investments. “Quality” refers to well-established companies with plenty of resources. These organizations are typically larger than more well-known, riskier companies.
If you’re searching for quality companies online, look for:
- Larger market capitalization
- Low debt and steady or high profitability
- Steady cash flow
- Excellent or above-average security price performance
- Common stocks
- Steadily growing sectors
You may also want to look into blue chip companies, which tend to be more mature than their sexier up-and-coming counterparts. These have more predictable business and cash flows, as well as larger reserves to weather economic downturn. Furthermore, many blue chip companies pay out dividends, which can be a crucial component of your recession strategy.
While shares of any quality company aren’t bulletproof, they tend to hold their weight better than shares of riskier companies. Many quality companies also have a tendency to lag during bull markets as people look to take bigger risks when the markets perform well, which means they can be woefully overlooked in good times.
Think About Investing in Funds
Mutual funds, ETFs, and low-cost index funds can provide some buffer against the risk of individual stocks. During a recession, then, investing in these opportunities can help you weather the storm and even make a profit in the process.
Funds are baskets of securities, which means that you purchase a piece of hundreds securities rather than a single share of a handful. During a recession, investing in a fund that tracks resilient sectors or indices can help you diversify your portfolio and your risk. With a fund, if one or even several companies underperform, strong performance from the rest of the basket can offset the potential losses.
What About the Income?
During times of recession, many investors look to bonds or dividend-paying stocks for their routine payouts. This is one way to hedge against losses while bolstering your income at the same time, even in times of economic downturn.
Bonds, or fixed-income securities, are essentially loans issued by governments or corporations. You lend a set amount of money to the borrower, and in return, you receive interest payments until the bond matures in one to thirty years. At the end of that time, the borrower pays back the principle of the loan. The interest on the loans is what many find attractive during a recession, although the promise of a safe(ish) place to store money for a decade or two is alluring as well.
Dividend securities, on the other hand, are stocks or funds that pay out a percentage of its profits to investors. Investing in companies or firms with a history of paying – and increasing – dividends is one way to ensure steady cash flow year-round, especially during a recession. It’s important to look at consistency in payouts as well as yield, as higher yield is indicative of higher risk.
Ignore the News (Within Reason)
The last thing to consider during a recession is that news, while imperative to keeping us connected, isn’t always your friend in the financial world. Keeping tabs on your investments is a good thing – until constant coverage on a sudden market downturn causes you to panic and sell all of your investments in one fell swoop.
Unfortunately, news corporations are bound to the same capitalist society as the rest of us, which means they have to chase profits as well as a good story. This means that they often play to human emotions to sell stories – and nothing sells better than greed and fear.
These emotions are naturally inherent in a recession, which means it’s easy to capitalize on their effects. The headlines that come out of economic downturn can be particularly persuasive in making you think the financial world is collapsing to its knees. (If you pay attention, some outlets do this even in the midst of a raging secular bull market).
It’s important, then, to discount the hype and bet on yourself, rather than the panicking newspapers. While you can use the news to understand the situation, rushing out to trade your positions at the first questionable headline can cause you to lose your best chances at coming out on top during the recession.
Anticipating and carefully regarding a panicked news cycle is the best way to ensure your focus and discipline during a recession. Unfortunately, a lot of people abandon their strategies solely due to what the news cycle said on Thursday.
Don’t let that be you.
A Final Word on Investing During a Recession
While we’ve seen historic returns over the past decade, we’ve also seen how damaging a pandemic can be on the global markets. It’s important to understand that national and global (or in this case, medical) events can have a volatile impact on the markets.
Therefore, keeping your head, investing in solid positions, and diversifying your portfolio further throughout the recession are key to increasing your wealth and building a recession-proof portfolio. And remember, as discomfiting as a recession may be, it’s also a natural occurrence in the economic cycle.
Know this: 2020 wasn’t the first time – and it certainly won’t be the last.