Recession-Proof Your Money: Smart Investment Strategies

Recessions are a normal part of the economic cycle, and while they can be scary, they also present opportunities for investors. If you're wondering how to prepare your portfolio for a recession, here's an introduction to the types of investments that tend to perform well during economic downturns.

One strategy is to focus on defensive sectors, such as healthcare and consumer staples. These sectors tend to be less volatile during recessions because they provide essential goods and services that consumers will continue to demand even when times are tough. Large-cap stocks in these sectors, with their strong balance sheets and cash flows, are particularly attractive as they are better equipped to weather the storm and often pay dividends.

Another approach is to seek out high-quality stocks with low debt, positive earnings, strong cash flow, and low volatility. These companies are more likely to ride out the recession and offer some stability to your portfolio.

Additionally, investing in dividend-paying stocks or funds can provide a cushion during a downturn, as they offer routine cash payments, and some even allow for reinvestment of dividends to further boost your returns.

Bonds are also a popular choice during recessions, as they provide periodic payments and are often seen as a safe haven due to their low correlation with stocks.

Finally, don't underestimate the value of cash and cash equivalents, such as CDs and money market accounts, during a recession. While they may not offer high returns, they provide a safe place to park your money and protect your capital.

Remember, investing during a recession requires a careful assessment of your financial situation, risk tolerance, and time horizon. It's essential to do your research and consult with a financial advisor before making any investment decisions.

Defensive stocks: healthcare, consumer staples, utilities, defence contractors, funeral services

Defensive stocks are stocks that provide consistent dividends and stable earnings regardless of the state of the overall stock market. They are considered safer investments during a recession.

Healthcare

The healthcare sector includes pharmaceuticals, medical devices, and healthcare services. Demand for healthcare is generally non-cyclical as it is a basic need. A study found that healthcare hiring remained stable in spite of economic downturns. Healthcare employment often increases in response to economic turmoil, and this trend is more pronounced during national recessions.

Consumer Staples

This sector includes food and beverages, tobacco, household items, and hygiene products. These are goods that people tend to buy out of necessity. Demand for these products remains relatively constant, making this sector less sensitive to economic cycles.

Utilities

This sector provides essential services like electricity, water, and gas. Demand for these services also remains relatively constant, making the sector less sensitive to economic cycles. During the last three recessionary periods, the utilities sector outperformed the S&P 500 by up to 17% from the beginning to the end of the recession.

Defence Contractors

Defensive stocks should not be confused with defence stocks, which are stocks of companies that manufacture weapons, ammunition, and fighter jets.

Funeral Services

Funeral services can be considered a consumer staple, as people will always need them regardless of economic conditions.

Defensive stocks tend to perform better than the broader market during recessions, but they often perform below the market during an expansion phase due to their low beta or market-related risk. They are also known as non-cyclical stocks because they are not highly correlated with the business cycle.

High-yield stocks: gold, silver, precious metals

Gold, silver, and other precious metals are a great investment option to hedge against various economic crises. Gold, in particular, has historically been used as a hedge against inflation and as a safe-haven investment during times of political uncertainty.

Gold prices tend to move in the opposite direction of interest rates and the value of the dollar. When the dollar is strong, gold prices tend to dip, and vice versa. Gold also tends to be pulled down with other stocks during a recession, but it will be one of the first things to bounce back and increase in value throughout.

Goldmine investment is an example of an indirect investment in precious metals. Exchange-Traded Funds (ETFs) that consist of many different gold mining companies might be a better way to invest than putting all your money into the stock of just one gold mining company.

Gold has outperformed other precious metals during every US recession since 1971. This is because gold is primarily used as money, while silver, platinum, and palladium are mostly used in industrial applications. In a recession, demand for commodities declines, so the demand for these metals decreases relative to gold.

However, this does not mean that silver and platinum prices always decline in a recession. Monetary demand can offset the decline in industrial demand for these metals. Additionally, silver and platinum prices can be idiosyncratically driven by the negative performance of one particular metal due to supply issues.

Therefore, investing in gold before a recession can be a good idea, but it is important to keep in mind that gold prices can initially decline during a recession, along with other stocks.

Dividend stocks: common stocks, mutual funds, ETFs

Dividend stocks are a good investment option before a recession as they provide a stable cash flow even during recessions. They are shares of a company that splits a portion of its profits with its shareholders based on the number of shares they own.

• Look for companies with a strong track record of paying and increasing dividends: Investing in companies with a history of paying and increasing dividends can lead to stable cash flow even during recessions. Dividend-yielding investments can be a good source of routine cash payments during recessions.
• Reinvesting dividends can reduce volatility: Reinvesting dividends can lower the volatility of your portfolio. For example, if the stock market is down 10% but the dividend you receive is reinvested, you won't experience as much of a loss.
• Consistency in dividend payments is more important than yield: When choosing dividend-paying stocks or ETFs, look for companies with a consistent track record of paying or increasing dividends, rather than those with the highest yields, as higher yields often come with additional risk.
• Consider dividend ETFs: Dividend ETFs are made up of companies known for routinely paying strong dividends. They can provide both defensive positioning and income during market stress. Examples include the Vanguard Dividend Appreciation ETF (VIG) and the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD).
• Focus on companies with strong balance sheets and stable cash flows: Companies with strong financial foundations, steady cash flows, low debt, and positive earnings tend to be more resilient during economic downturns.

Mutual funds and ETFs are also good investment options to consider before a recession. They can provide diversification and exposure to specific sectors or industries that may be more resilient during a downturn. Here are some options to consider:

• Sector-specific funds: Funds that track specific sectors, such as healthcare and consumer staples, can be a good choice as these sectors tend to outperform during recessions. Examples include the iShares US Healthcare Providers (IHF) and the Consumer Staples Select Sector SPDR ETF (XLP).
• Low-cost index funds: Investing in low-cost index funds can be a less risky option than investing in individual stocks. They provide exposure to a basket of securities, reducing the risk of concentrating your investment in any one company.
• Fixed-income investments: Bonds and other fixed-income investments, such as bond funds, can provide periodic payments and stable returns during recessions. During a recession, the Federal Reserve may cut interest rates to stimulate economic growth, making longer-duration bonds more attractive.

Fixed-income investments: bonds, dividend-yielding investments

Fixed-income investments: Bonds and dividend-yielding stocks

Fixed-income investments are a good option to consider during a recession, as they can provide a stable, fixed income stream. They are also in higher demand than dividend stocks during a recession because lending money with a bond is less risky than owning part of a company through the stock market.

Bonds

Bonds are units of debt issued by companies and governments as tradable assets. When you invest in them, you lend money to the issuer (the company or government) in return for regular payments, usually made once or twice a year. At the end of the bond's term, you get back the initial amount you invested.

During a recession, the interest rates offered by savings accounts and other interest-bearing accounts tend to be low. In contrast, bonds can offer a more attractive income.

There are several types of bonds to choose from, each with different levels of risk.

• US Treasury Bonds/Federal Bonds: These are issued by the Federal Reserve System, which collects taxes, determines monetary policy, and can print money. As a result, there is little to no risk of default on these bonds, making them a safe investment.
• Municipal Bonds and TIPS: Issued by state and local governments, these bonds are considered secure due to the taxing authority of the issuers. However, they carry more risk than federal government bonds because they are not backed by the central bank.
• Taxable Corporate Bonds: These offer greater yields than federal or municipal bonds but also carry more risk. It is essential to choose high-quality corporate bonds to mitigate default risk.

When investing in bonds during a recession, it is best to opt for short-term bonds with shorter maturity dates. This is because, during a recession, the yields paid on bonds can decline, and shorter-term bonds offer more liquidity.

You could also consider investing in mutual funds that invest in various bonds (also known as bond funds). These are actively managed by a bond manager or investment team, who conduct economic research and track the bond's yield curve to make informed investment decisions.

Dividend-yielding stocks

Dividend-yielding stocks are shares of a company that pays out a portion of its profits to shareholders based on the number of shares they own. Dividend-yielding stocks and ETFs (which are made up of companies known for paying strong dividends) can provide a stable cash flow even during recessions, especially if you invest in companies with a strong track record of paying and increasing dividends.

When searching for dividend-paying stocks or ETFs, look for consistency in paying or increasing dividends, which indicates good corporate governance. While yield shouldn't be the determining factor, reinvesting dividends can help to lower the volatility of your portfolio.

Risks

While fixed-income investments can be a good option during a recession, there are some risks to consider.

During a recession, some companies, particularly highly indebted ones, may go bankrupt. As a result, investors holding corporate bonds issued by these companies will lose their principal investment.

Additionally, high-yield or junk bonds, which usually pay a higher yield, carry a higher credit risk. During a recession, the price of these bonds generally falls.

Real estate: rental properties

Rental properties are a great investment to make before a recession. Here's why:

Stability and Appreciation

Real estate, especially rental properties, tends to be more stable during recessions compared to other investments. While home values may experience a slight decline, rents generally remain steady, and demand for rentals can even increase due to fewer people buying homes.

Over the last 70 years, real estate values have continued to rise, despite numerous recessions. In fact, there have been instances where property values have increased during economic downturns. Even if a recession causes a hot housing market to cool down, investors can take advantage of discounted rates.

Basic Necessity

Housing is a primary need that is always in demand. During a recession, people may lose their jobs, earnings, and sometimes their homes. As a result, it can be relatively easy to find tenants. While individuals may choose to forgo purchasing a new phone or car, they are less likely to opt to live on the streets.

Resilience and Cash Flow

Rental properties are more resilient to economic downturns compared to commercial properties. The coronavirus pandemic highlighted the resilience of housing, while commercial properties like retail and office spaces faced growing vacancies as people worked remotely.

Rental properties also offer stable cash flow. Even after subtracting monthly operational expenses and mortgage payments, some properties continue to generate strong cash flow, reducing the risk of a recession.

Tax Advantages

Private real estate investments, such as rental properties, are not traded daily like stocks, providing stability when stock prices fluctuate erratically. Additionally, real estate investments offer tax advantages, such as depreciation, which can help offset taxable income.

Tips for Investing in Rental Properties During a Recession

When considering rental property investments, it is crucial to:

• Focus on locations with strong income levels, diversified employment, and robust population migration.
• Pay attention to trends, such as whether individuals are seeking urban or rural residences.
• Prioritize cash flow by seeking properties that generate stable cash flow after expenses and mortgage payments.
• Compare financing options and keep an eye on interest rates and lending options in the mortgage industry.

Frequently asked questions