Dec 29, 2022
Even if the next economic recession is only moderate, investors must consider how their portfolios will be structured.
According to Michelle Griffith, "cash is king" when the economy is through a slump. It is preferable to be safe than sorry and bulk up financial reserves during periods of high employment since corporations are cutting down and the number of people losing their jobs is increasing.
However, there is a danger involved in selling assets to get cash in preparation for an economic recession. You risk selling too soon and finding yourself stuck with cash as the markets continue to climb. Changing your assets to ones in a strong position to withstand the effects of a recession is a more effective technique.
Because of this, it is always a good idea to maintain a certain portion of your investment portfolio in cash or highly liquid products, such as a money market mutual fund.
Consumer discretionary stocks often see significant price increases when the economy is doing well. They are referred to as cyclical stocks because profits and losses in this stock category depend on the ups and downs of economic cycles and confidence levels among consumers.
Stocks of defensive companies operating in non-cyclical industries, such as utilities and consumer staples, tend to be immune to the ups and downs of the market. Holding defensive stocks might benefit your portfolio when the economy is in a downturn.
It doesn't matter how badly the economy is doing; people will always need to eat and use toilet paper. As a result, sales of consumer staples such as food, drinks, and home items remain mostly unaffected by economic downturns. A recession does not significantly affect the level of demand for utilities, which helps utilities outperform stock sectors during a period of economic contraction.
In a paper published in 2021, experts from the NBER said that "the health care industry is stable across the economic cycle." "When counties undergo more severe economic downturns, it appears that employment in the healthcare industry actually increases,"
The method of investing known as dollar-cost averaging involves making consistent purchases of a predetermined quantity of an asset, regardless of the asset's price at the time of purchase.
Recessions provide excellent chances to use a strategy known as dollar-cost averaging since it allows investors to purchase shares at lower prices over time. You may use $ cost average with fresh money, or you can set dividends to automatically reinvest in security, which would serve same goal. Both of these options are available to you.
According to Katz, "in order to safeguard a portfolio during a downturn, investors should look for quality across all asset classes." Quality investments will have a low beta, a good investment return, and minimal leverage, among other characteristics.
He refers to firms like this as "all-weather businesses" since their success is not contingent on the rate at which the economy grows. Businesses that rely heavily on recurring income streams, such as subscription-based sales models, have a lower sensitivity to economic fluctuations.
According to him, you should steer clear of businesses with huge debt burdens since they could have difficulties paying their debts if their sales and cash flows fall. If credit conditions and lending standards were to tighten, they might also have difficulty refinancing debt before its expiry.
Investors should avoid buying growth equities when the economy is showing signs of potentially entering a recession. According to Nakadi, "Growth equities, particularly loss-making corporations that are related to strong growth potential, perform poorly during recessions." Instead, you should give greater thought to assets that provide income and equities that pay dividends.
Your investment portfolio will benefit from having the top dividend companies as a buffer against market downturns. A corporation may keep paying dividends even if its stock price drops. According to Griffith, "dividends may be an indication of strength and give a mechanism to dollar cost average during periods of market volatility."
During a recession, it may be beneficial for fund investors to transition into actively managed funds. After making adjustments for risk and fees, the majority of actively managed funds outperformed their counterparts by 4.5 to 6.1 percentage points each year in declining markets, according to research.