Investment Strategies for a Recession: How to Protect Your Portfolio
If you have ever taken economics 101, you likely already know that economies and financial markets move in cycles. As such, recessions are part of a normal economic cycle - but they're certainly not the most fun part. Fortunately, downturns almost never last as long as periods of growth.
Still, recessions can be scary. It can be helpful to remember, that news commentators are not economists and a recession doesn't always spell economic gloom and doom. In fact, you've probably already lived through several recessions, and you'll likely experience a few more in your lifetime.
Right now… stubborn inflation, the war in Ukraine, persistent COVID-19 outbreaks, and a frustrated populace who have just lived through a global pandemic aren’t making things easy on the economy. Perhaps, a recession will come in the near future, or it may come later on. No one can tell you exactly when, but one thing is certain: recessions are inevitable. We have to learn to live with them.
Recessions don't have to create panic, but they do require a cool head and a solid financial plan. Let's dive into recessions and recession-conscious financial and investment planning.
What Is a Recession?
The word recession is thrown around a lot, and it can get a little confusing.
A recession is measured by the broad economy rather than the financial markets, though the two can be linked.
What is a Recession?
During the 1980 presidential election, then-candidate Ronald Reagan said a recession happens "when your neighbor loses his job" and a depression is when "you lose your job." That's probably the best definition given yet, but it's not strictly accurate.
Generally, when economists talk about a recession, they mean a significant decline in economic activity across a defined region, usually a country or continent.
Specifically, when an economy experiences two or more consecutive quarters of economic decline, economists call it a recession. Usually, this decline is accompanied by negative monthly indicators. These can include rising unemployment, declining production, or a jump in business failures.
How Long Does a Recession Typically Last?
According to the National Bureau of Economic Research, the U.S. has experienced six periods of economic recession since the 1980 recession. The shortest of these, the COVID-19 recession of 2020, lasted two months. The longest was the Great Recession of 2008-2009, which lasted 18 months. However, the average recession in America after World War II is about 11.1 months.
Predicting the length of an economic contraction is often a fool's errand. You generally only know it’s over after the economy has turned around into an expansion.
Are We In a Recession?
As of June 2022, the U.S. economy is not in a recession. Yes, growth has slowed, consumers are jittery, and inflation is spiking. Those facts may signal a recession is ahead, but we are not yet in the storm.
That doesn't mean we're out of danger, though. According to Bloomberg’s recent survey, there’s a 30% consensus among economists that a recession will occur over the next 12 months. Deutsche Bank has predicted a recession that will start in late 2023 and end in mid-2024. The bank bases its forecast on the historic relationship between unemployment rates, inflation, and recession.
Other economic observers claim that Deutsche Bank is too pessimistic. Goldman Sachs has stated that a recession is not inevitable though a significant slowdown in economic growth is likely.
How Do Recessions Affect the Average Investor?
Recessions have a tendency to impact our daily lives and behaviors.
Unusual employment trends. Often, a recession is associated with higher unemployment rate. That’s what happened in 2008 when unemployment jumped above 10%. Such a drastic change is not always the case. In the 2001 recession, the increase in unemployment wasn’t nearly as extreme.
Increased savings. American consumers typically restrict spending and load up on savings during a recession. Fears of a job loss or other financial challenges ahead often drive this behavior.
Decreased investments. Many investors stop funding their investment accounts during a recession. Sometimes, they do it to bump up their reserves (savings). Other times, it's purely an emotion-driven decision - fear that when the financial markets are down, they might not come back around.
Reduced volume of goods and services. Manufacturers expect they will sell fewer products during a recession. Until consumer confidence improves, factories often produce fewer products to take to market.
Lower prices. Recessions can help tamp down inflation and drive prices lower, especially for consumer goods and in some cases real estate.
Restricted access to credit. Banks often tighten up on mortgages, auto loans, and lines of credit, especially for high-risk borrowers. If you're looking to buy a house in a recession, you may find that prices are in your favor but banks may be reluctant to help fund your purchase.
Are There Benefits to a Recession?
Recessions offer a valuable — if often painful — service to the economy.
First, they can help weed out inefficiencies. During a recession, companies tend to tighten non-essential expenses, eliminate vanity projects, and streamline their processes. Recessions also tend to sweep aside old technologies and encourage workers to boost their resumes to leverage additional opportunities.
Second, recessions can help reduce inflation. As demand decreases companies tend to lower prices. Also as unemployment rises, wage increases tend to stall. If wages kept rising prices would often follow suit. For working people, that might be okay. But for Americans living on a fixed income, including many retired workers, that can be a recipe for financial disaster. Recessions help reset the economy for everybody.
Finally, recessions encourage saving and can provide opportunities for investors. Consumers curtail excess spending during a recession and tuck that money into a savings account. Recessions often remind us of the importance of living within our means, which in general, is smart behavior for personal financial freedom. It's important to spend less than we earn and build reserves and liquidity, and recessions often provide the motivation people need to do just that.
Investment Strategies in a Recession
Should you continue to invest during a recession? Can you limit your losses? Maybe even make money?
The stock market's relationship to economic contraction is not crystal clear. A bear market (a 20% or more drop in the stock market from its recent high) does not always indicate a recession and a recession does not always result in a bear market. In fact, a recession can present certain opportunities for your investment portfolio.
No one knows how deep or how long a bear market will go, and no one knows what the rebound will look like. While it could last longer than you hope, it could also present you with a chance to rebalance your portfolio, consider some tax-loss harvesting (a tax-reduction strategy), and purchase new investments at discounted prices. While prices are low now, the financial markets have time and time again come back around.
Real estate investments tend to follow a more predictable trend. Home prices can drop, sales tend to slow down, and mortgages can get more expensive. A recession-driven market is often good for buyers and tough on sellers.
What's Your Investment Goal in a Recession?
Your investment strategy should match your goals.
Most investors have long-term goals, short-term goals, or both. You know whether your goals are long-term or short-term based on whether you believe you will need to withdraw your money in three years or less.
During a recession, achieving even one of these goals can create a positive impact on your financial future. Knowing what you want to achieve is key to developing your investment strategy. Don't lose sight of your big-picture goals - especially during a recession.
How Can You Preserve Your Capital During a Recession?
When markets fall, it can be tempting to “do something.” Contrary to that temptation, staying the course (or doing nothing) is often the better path. Historically, staying invested in a properly balanced and diversified strategy can help preserve your wealth long-term.
How do you know if you have a well-diversified strategy? Consider being invested across a wide variety of stock types — large and small, domestic and international — and bonds, including treasuries, corporates, and in some cases varying maturities. Historically, these different types of stocks and bonds have gone through periods of time differently. Some tend to drop more, while others have dropped less. Bonds often outperform stocks during bear markets and sometimes during a recession.
In Ecclesiastes 11, Solomon reminds us “Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.” Scripture does not say we will be protected from these disasters, but warns us of the danger of putting all our “eggs in one basket.”
What Are the Most Recession-proof Investments?
Nothing is foolproof. Outside of keeping all your money in cash (which has its own risks, inflation for one), all investing involves some degree of risk. However, you can help further diversify your investments to reduce some risks by utilizing mutual funds or ETFs, instead of individual stocks. Doing so can reduce the individual business risk of owning a single company's stock.
Consider the fate of investors in companies such as Enron or Lehman Brothers. When these high-performing companies unexpectedly tanked, many investors were left with pennies on the dollar for their investments. While investors with more diversified portfolios likely took a much smaller hit. Diversification - the same principle applies to recession-proof investing.
How to Invest Before, During, and After a Recession
Investing Before a Recession
It's tough to time a recession, so in one sense, we're always investing before a recession. If you're still building your retirement nest egg, you'll likely want to keep putting money away according to the plan you created with your wealth management advisor. If it’s money you won’t need for five or more years, you’re likely positioned more towards assets with the potential to grow, such as stocks, which are more volatile. If you're drawing on your retirement account now, you’ll want to consider the amount of cash and bonds you hold, which tend to be more conservative and less volatile investments. That doesn’t necessarily mean you should be in all cash and bonds, instead make an appointment with your investment advisor to discuss recession-resistant strategies.
Investing During a Recession
Most often, the best answer is to do nothing drastic - Don't necessarily get out of the market or stop investing. In one study of 10,000 millionaires, researchers found the most common factor in their investment strategy was consistency. External factors didn't influence their behavior.
Millionaires didn't stop investing when things got tough. They didn't try to time the market. They just kept going. With that said, taking the time to have a well-developed investment strategy before the recession is key.
Investing After a Recession
If you invested during the recession, you will probably start to see the benefits of having bought those investments at discount prices. Don't stop, though. Stick with your plan, and where adjustments are needed for your long-term success make them.
Common Mistakes Investors Make During Financial Downturns
Mistake #1 — They panic.
You rarely, if ever, make a good decision in an emotional state. Instead, make choices when you're thinking and behaving rationally and you have a solid team working with you.
Mistake #2 — They get overconfident.
Just because you can buy stocks at discount prices during a recession doesn't mean you always should. Talk to your wealth management professional before you do anything.
Mistake #3 — They cash out of the market.
Running to cash can be risky. It may feel safe at the time, but in the end, the market is likely to recover, and you'll have little to show for it. The biggest benefits often belong to the people who stay committed to their well-thought-out plans through good times and bad.
Mistake #4 — They obsess over Wall Street's daily performance.
As of 2022, the US market’s, measured by the S&P 500 Index, 10-year annualized return is above 12% and that’s having gone through 2 bear markets. Remember downturns don’t last forever. Instead of focusing on the day-to-day movement of the markets, look at long-term returns. Try not to worry about a single day, week, or month.
How to Protect Your Portfolio From Recession
In addition to what we’ve already mentioned… Don't try to weather a recession alone. One of the best ways to help protect your portfolio from a recession is to have a well-thought-out strategy and to stick with it. Work with a dedicated and knowledgeable wealth management team to help get you there. Call us today at Cooke Wealth Management to discuss how you might protect your wealth from a recession.