How to Recession Proof Your Investments `

How the recession affects your investments

The National Bureau of Economic Research (NBER) defines when the US economy is in recession. It defines a recession as “a significant reduction in economic activity that spreads throughout the economy and lasts for more than a few months.”

As the economy weakens, people withdraw money from the financial markets because they expect companies (and therefore their securities) to perform worse, need investment money for living expenses, or both. This causes the prices of stocks and other securities to fall. How long and how deep this decline is depends on how bleak the economic data is and how much it undermines investor confidence.

Recessions can affect your investments in the following ways:

• Investment losses: A decline in financial markets can reduce the value of your investments. For example, the Great Recession was closely associated with a major downturn in financial markets. The S&P 500 peaked at 1,576.09 in October 2007 and bottomed at 666.79 in March 2009—a decline of almost 58%. The NBER called the recession the period from December 2007 to June 2009.
  Investment losses are not limited to stocks. Other asset classes like real estate are also affected. If you consider your home an asset and the housing market crashes, you may be in your home.
• Loss of investment potential: Many people lose their jobs during a recession. Between December 2007 and 2008, unemployment rose from 5% to 7.2% when 3.6 million people lost their jobs. Without a job to provide income, many people had to withdraw money from their portfolios to cover expenses, meaning they missed out on the opportunity to recoup their losses when the market recovered. They also missed out on investing more during a downtrend in the market. investment potential.
• Finding retirement savings early: Many workers, especially those close to retirement, are forced into early retirement due to job losses during the recession. This causes them to dip into their already depleted retirement savings sooner and longer than they expected.
  It can go the other way. If the erosion of your nest egg makes you feel like you don't have enough savings for retirement, you may have to put your retirement plans on hold.

What to do before recession

not only important for your investment portfolio, but also for your overall financial health. However, there are some steps you can take to prepare your portfolio to weather the storm.

Assess your financial situation

Taking a step back to look at your overall financial situation can be a good starting point to insulate your investments from the effects of a recession.

Although not everyone can follow this, Chicago-based CFP Henry Gorecki recommends budgeting 70% for your needs, 10% for retirement, 10% for savings, and 10% set aside. to have fun Having some savings or an emergency fund can help cover your expenses in case of financial difficulties without having to sell your investments.

It can also be good practice to take this time to assess your risk appetite. Your risk tolerance will determine how much investment volatility you can stomach and what types of investments you are most comfortable with.

Diversify your investments

Even if a recession isn't imminent, it makes good sense to diversify your investments. A well consists of investments that do not move in the same direction. It helps to manage risk and losses. The value of one investment may rise and another may fall due to specific economic factors.

Diversification involves spreading your money between aggressive assets like stocks while also investing in less volatile securities like bonds. Historically, bonds lose less value during recessions and can help offset some of the losses in stocks. Asset classes such as gold are considered safe havens or investments that investors flock to when stocks are in a downtrend.

Defense Sector Allocation

Weighting your portfolio can help limit losses during a market downturn.

“Traditional advice is to put money into 'defensive' sectors — typically health care, consumer staples and utilities — before a recession,” said Louisiana CPA Riley Adams. “And on the face of it, it makes sense. “When money is tight, you can put off buying another pair of Lululemon leggings or a bigger TV, but you can't keep spending on prescriptions, groceries, and electricity.”

Dividend Investment

is a great way to get a return on your investments. Companies often reward their shareholders by paying dividends. Investors can either take those dividends as income or reinvest them to build a larger position in the stock.

Investing for dividends is a sound strategy even when the economy is doing well, but it can be extremely beneficial during a downturn because you can reinvest those dividends to buy the same stocks at cheaper prices.

Dividend-paying stocks outperformed the broader market during the recessions of 1981, 2001 and 2007, according to Morningstar's data analysis. However, dividend-paying stocks underperformed markets during the brief 2020 downturn.

What to do in a recession

It may seem overwhelming, but the best thing for investors is to stay the course and continue to buy the market. As Warren Buffett once said, it is wise to be “fearful when others are greedy, and greedy when others are fearful.”

Invest more as stocks go down

Although it may sound counterintuitive, dips allow you to buy stocks of companies at prices well below their normal value. This is called taking a dip. This is beneficial because not only do you get a discount compared to the normal values ​​of these companies, but you also have the chance to gain more if the stock prices rise again. Having a well-diversified portfolio allows you to take advantage of these low prices while minimizing any company's risk during a bad economy.

Strategies like this can help ensure you buy more when prices are low and lower your average investment cost. or periodic investments through (DRIP) can help you make small stock investments even when markets continue to fall.

Rebalancing if necessary

In an environment where economic indicators are shaky and markets are generally down, the balance of assets in your portfolio is likely to change as some securities lose more value than others. during a downturn it also means evaluating your investment performance and reallocating your money across sectors and asset classes if it doesn't match your risk tolerance and long-term investment goals.

For example, if you've decided you want 15% of your portfolio in international stocks, and those stocks are so good compared to your other assets that they're worth more than the 15% threshold, you might want to sell some of them. more in other sectors to reach your target allocations.

Check out The Real Estate Game

Another consideration is that interest rates tend to fall during recessions as the US Federal Reserve aims to increase the money supply and help the economy recover. This can make recessions an attractive time to use leverage, such as investing in real estate.

What to tell yourself if things go wrong

Here are some good reminders to keep you from hitting the sell button as the markets turn sour.

Recessions and Bear Markets Don't Last Forever

Although recessions are scary, they don't last forever. According to the NBER, the average duration of a recession is 17 months. The shortest occurred in 2020 and lasted only two months.

Studies also show that stocks can begin to recover their losses even before a recession is officially announced. And ups usually last longer than downs. Lazard Asset Management analyzed 14 examples of bull and bear markets experienced by the S&P 500 between 1926 and 2020. The average bear market lasted 20 months and averaged a negative 41% return. The average bull market lasted 51 months and the index returned an average of 162%.

Panic Selling is Wrong

When you see your investment account balances plummet, it's easy to think about cashing out to cut your losses. However, panic selling your investments not only leaves you with losses, but also gives up any potential gains once the markets recover.

“Spend 15 minutes evaluating each holding—earnings expectations, recent news, valuations—and ask yourself, 'Do I want to sell this for any reason other than the recent price drop?' If the answer is still yes, that's fine. But don't let fear make you panic and sell out,” Adams said.

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