Recession Risks: Strategies To Protect Your Investment Portfolio

A recession can be a scary time for investors, with stock values declining and market volatility increasing. However, it's important to remember that recessions are a normal part of a functioning economy, and there are strategies to help you navigate this challenging period. Firstly, it's crucial to assess your financial situation and risk tolerance. If you have a strong financial position, a long time horizon, and a high tolerance for risk, you may be comfortable continuing to invest during a recession. On the other hand, if your finances are unstable or you have a short time horizon, you might want to hold off on investing. Building an emergency fund and prioritising debt repayment can be wise in such situations.

During a recession, certain sectors tend to be more resilient, such as healthcare, consumer staples (including food, beverages, and household goods), utilities, and defence contractors. Investing in large-cap stocks with low debt, profitability, and strong balance sheets can also be a good strategy. Additionally, diversification, value investing, and dollar-cost averaging are time-tested approaches to reduce risk and take advantage of market opportunities. Remember, investing during a recession requires a long-term perspective, and it's crucial not to panic and make rash decisions.

Defensive stocks

During a recession, riskier assets like stocks and high-yield bonds tend to lose value, while gold and U.S. Treasuries appreciate. Defensive stocks are those of large, reliably profitable companies with strong balance sheets, ample and steady cash flows, and healthy dividends. These companies have a long track record of weathering downturns and bear markets.

Some sectors that produce goods and services that people cannot do without tend to withstand recessions better than others. These include consumer staples, utilities, and healthcare.

• The Procter & Gamble Company (NYSE: PG): This multinational consumer goods company manufactures and distributes personal health and hygiene products. It has a reliable dividend growth history and has outperformed the Consumer Staples Select Sector SPDR Fund over the last five years.
• Johnson & Johnson (NYSE: JNJ): One of the largest healthcare companies by market cap, Johnson & Johnson focuses on oncology and immunology, and also develops medical devices and pharmaceuticals. Its stock usually remains stable regardless of economic conditions.
• Walmart Inc. (NYSE: WMT): Walmart is a discount retailer that has thrived during almost every economic downturn. It has a reliable dividend growth history, making it a dividend aristocrat. Recent investments in automation have positioned it well to maintain low prices and spur growth during uncertain economic conditions.
• Synopsys, Inc. (NASDAQ: SNPS): Synopsys is an electronic design automation (EDA) company that provides a platform for engineers to design and test semiconductor chips and other software applications. The semiconductor industry tends to be stable even during recessions, and Synopsys outperformed the S&P 500 by significant margins during the 2008 and 2020 recessions.
• NextEra Energy Inc. (NYSE: NEE): NextEra Energy is the world's largest producer of wind and solar energy, and it plans to double its capacity by 2025. It has increased its dividend at a compound annual growth rate of almost 11%.

Emergency savings

Revisit and Adjust Your Savings Goals:

It's advisable to save enough to cover at least three to six months' worth of living expenses. Even if you can only set aside a small amount each month, developing a regular saving habit is essential. Consider increasing your savings contributions if you have a steady income, with the goal of fully funding your emergency savings.

Keep Your Savings Liquid and Accessible:

Place your emergency fund in a high-yield savings account to ensure easy access when unexpected expenses arise. While earning interest is important, your primary goal should be liquidity and safety. Look for accounts with minimal withdrawal restrictions and no fees for withdrawing your money.

Cut or Negotiate Expenses:

Evaluate your expenses and identify areas where you can reduce or negotiate costs. Re-examine your needs and lifestyle to find opportunities for reducing spending. For example, consider negotiating bills for cell phone plans or cable services.

Avoid Accumulating High-Interest Debt:

Economic uncertainty is the time to reduce debt, not increase it. Avoid taking on extra debt due to large, unnecessary purchases. Credit cards often come with high-interest rates, so explore alternatives like zero per cent promotional interest periods or balance transfers to more favourable credit options.

Don't Be Discouraged by Low Savings Rates:

While savings account rates at traditional banks may be low, online banks and credit unions often offer higher yields. Shop around for the best rates, as some high-yield savings accounts provide rates more than 15 times the national average.

Maintain Long-Term Financial Goals:

While navigating a recession, don't lose sight of your long-term financial objectives. Ensure your retirement portfolio aligns with your retirement age and risk tolerance. If you're closer to retirement, gradually mitigate risk by exploring passive income streams for the near future.

Building emergency savings is a crucial component of financial resilience, especially during challenging economic times. By following these steps, you can strengthen your financial security and be better prepared for unexpected expenses or financial setbacks.

High-cost debt

Impact on Individuals

During a recession, taking on new debt can be risky. This includes loans, such as car loans, home equity lines of credit, or student loans. The likelihood of job losses or reduced business income increases during a recession, making it harder to keep up with debt payments. It's important to prioritize essential expenses and maintain financial flexibility.

Impact on Businesses

For businesses, debt financing can be a way to manage cash flow and cover necessary expenses during a recession. It can help maintain positive cash flow and encourage growth. However, it's crucial to carefully consider the ability to make regular payments, especially if the business is in its early stages or has irregular customer payments.

Interest Rates and Credit Scores

Interest rates play a significant role in debt financing during a recession. Banks may increase interest rates during periods of financial instability, impacting borrowers' ability to make regular payments. Additionally, credit scores can be affected by taking out loans, and a low credit score may lead to higher interest rates on loans, making repayment even more challenging.

Alternative Options

Before taking on high-cost debt, it's worth considering alternative options. For individuals, this could mean building an emergency fund and focusing on financial security. For businesses, alternatives to debt financing include business grants, crowdfunding, or borrowing from friends and family, which may offer lower interest rates.

In summary, high-cost debt during a recession requires careful consideration. It's important to assess the ability to make regular payments, be mindful of interest rates and their potential impact, and explore alternative options to ensure financial resilience during challenging economic times.

Dollar-cost averaging

For example, an individual might decide to invest $150 every month in a particular mutual fund or exchange-traded fund (ETF). By doing so, they will purchase more shares when the price is low and fewer shares when the price is high, thus averaging out the cost per share over time. This strategy is called "dollar-cost averaging" because it aims to achieve an average dollar cost per share over the long term.

During a recession, dollar-cost averaging can be a good strategy for those who have the financial means and are committed to a long-term investment approach. Here are some key considerations and benefits of dollar-cost averaging during a recession:

• Reducing Risk: Dollar-cost averaging helps to reduce the risk of investing at the "wrong" time. Instead of trying to time the market, which is extremely difficult, this strategy focuses on consistent, regular investments. This means that investors avoid the potential pitfall of investing a large sum just before a market downturn or missing out on a rally by waiting too long.
• Smoothing Price Volatility: By investing at regular intervals, dollar-cost averaging smooths out the impact of price volatility. When the market is highly volatile, as it often is during a recession, this strategy can provide a more stable approach to investing.
• Long-Term Focus: Dollar-cost averaging encourages a long-term investment mindset. It is most effective when investors are committed to their investment strategy for several years, allowing time for the market to recover and grow.
• Behavioural Benefits: This strategy can help investors stick to their plan and avoid emotional decision-making. During a recession, it can be challenging to invest when the market is down, and many investors are selling. Dollar-cost averaging provides a disciplined approach that removes the need to make frequent investment decisions, reducing the potential for rash choices driven by fear or panic.
• Recession Opportunities: A recession can present good investment opportunities, as stock values tend to decline. Dollar-cost averaging allows investors to take advantage of these lower prices without the pressure of trying to time the market perfectly.
• Diversification: Dollar-cost averaging can be used in conjunction with other recession-resilient investment strategies, such as investing in consumer staples or large-cap companies with strong balance sheets and steady cash flows.

In summary, dollar-cost averaging is a powerful tool for investors during a recession, helping to reduce risk, smooth volatility, and encourage a long-term focus. It is a strategy well-suited to challenging market conditions and can provide a more disciplined approach to investing.

Actively managed funds

A study by Jie Chen et al. (2021) found that fund managers who started their careers during recessions tend to produce superior returns, even after accounting for various factors. These managers exhibit better market timing skills during recessions compared to their counterparts who began their careers in non-recession periods. However, they do not demonstrate better stock-picking abilities during economic booms. The study also revealed that fund managers with recession experience tend to tilt their investments towards defensive industries during and before recessionary periods.

Therefore, if your actively managed funds are handled by fund managers with prior recession experience, they may be better equipped to navigate the challenges of a recession and potentially generate positive returns.

• Market Timing and Diversification: Actively managed funds can attempt to time the market by adjusting their portfolio allocations. During a recession, defensive sectors, such as consumer staples (food, beverages, household goods, etc.), tend to outperform. Actively managed funds may seek to increase their exposure to these sectors while reducing investments in more volatile or economically sensitive areas. Diversification across asset classes is also crucial, as it helps to mitigate the impact of declining stock prices during a recession.
• Long-Term Perspective: It is essential to maintain a long-term perspective when investing in actively managed funds during a recession. Recessions are typically short-lived compared to expansions, and economies tend to rebound over time. As such, investors should focus on long-term growth rather than making impulsive decisions based on short-term market fluctuations.
• Risk Management: Actively managed funds can play a crucial role in risk management during a recession. Experienced fund managers can employ strategies to limit downside risks, such as investing in large, established companies with strong balance sheets and healthy cash flows that have a history of weathering economic downturns.
• Investment Opportunities: Recessions can present investment opportunities for actively managed funds. Lower stock prices during a recession allow fund managers to purchase shares of high-quality companies at favourable prices. However, it is essential to focus on companies with strong fundamentals and avoid speculating on stocks that have been severely beaten down.

In summary, actively managed funds can benefit from the expertise of fund managers, especially those with recession experience, who can navigate market downturns effectively. By employing strategies such as market timing, diversification, risk management, and seizing investment opportunities, actively managed funds can potentially generate positive returns during and after a recession. However, it is crucial to remember that past performance is not a guarantee of future results, and each recession is unique, presenting its own set of challenges and opportunities.

Frequently asked questions