How to Invest During a Recession
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Fears of a recession are understandably concerning for investors.
If you have a shorter time line for your investments, like if you’re planning to retire soon, you may be especially worried about how your portfolio will fare should the economy experience a downturn.
The Federal Reserve has repeatedly increased interest rates in an attempt to lower inflation without tipping the economy into a recession. However, many experts say a recession is likely.
Here’s what to do during a recession when it comes to your investment portfolio.
What to invest in during a recession
If you have a strong investment plan in place, the best move may be just sticking to that plan. But if you're concerned about where to invest, here are some investment options that may help you get closer to a recession-proof portfolio.
Dividend stocks
Stocks that generate dividends can be a good addition to a retirement portfolio, says Henry Yoshida, CEO of Rocket Dollar, an Austin, Texas-based self-directed individual retirement account provider. Dividends are regular payments companies make to shareholders in order to share profits.
Now that the market is down and interest rates are rising, it's better to invest in dividend growers — stocks with dividend rates that increase quarter after quarter — versus just looking for stocks that pay a high dividend percentage, Yoshida adds.
“In a recessionary, high-rate environment, a high-quality company that can raise their dividend shows that a company can maintain profitability even in a slumping economy,” Yoshida says. He adds that investors should make sure to keep an eye towards high-quality companies despite depressed stock prices and declining market sentiment.
“Growing dividends is typically correlated to high quality and sustained profitability,” he says.
Defensive stocks
When the economy is weaker and there are fewer purchases being made by consumers, stocks in food and beverages, household and personal care products, health care and utilities are defensive in nature, says Robert Johnson, a professor at the Heider College of Business at Creighton University.
“People need to eat, brush their teeth, go to the doctor and heat their homes whether the economy is strong or weak,” he adds.
Meanwhile growth stocks, which are stocks of companies expected to grow at a rate higher than the overall market, tend to not perform as well during a recession.
“Risk assets such as technology growth stocks that have had massive runups in recent years will underperform in a recession,” Yoshida says.
Bonds
Buying bonds could be a good option for some investors, Yoshida says. Bonds, like stocks, have had a bad year, and investors can take advantage of paying less for bonds, whose returns tend to be less volatile compared to stocks.
When interest rates rise, the value of bonds typically falls but when the opposite happens and rates fall, the value of bonds tends to rise.
What might make sense for some investors is to reduce the duration of their fixed-income portfolios as longer-term bonds fall in value more than shorter-term bonds in a rate rising environment, Johnson adds. One strategy is to sell the bonds with longer maturities and buy ones with a shorter time frame.
How to invest during a recession
In addition to what to invest in during a recession, you should think about how to invest during a recession.
Don't try to time the market
They key to investing during a recession — and investing most of the time — is not trying to time the market.
That's in part because often it is not known that the economy has entered a recession until after the fact.
“Stock markets are typically leading economic indicators so that if one waits to exit the market until we are in a recession, then markets have typically already fallen,” Johnson says “Likewise, if one waits to enter the market again when the recession has ended, the market has typically already risen.”
Financial advisors tend to recommend sticking to a long-term investing plan that is aligned with your risk tolerance, goals and timeline.
Have a diversified portfolio
Investors can also weather the ups and downs of the stock and bond markets and achieve their long-term goals by maintaining diversified portfolios, Johnson says.
Having a diversified portfolio means investing in various assets, like stocks and bonds. It also refers to investing in companies of various sizes and sectors, as well as both international and domestic companies. The idea is that when one area of your portfolio struggles, another area can hold steady or even do well.
Plus, it's often a good idea to opt for funds — baskets of securities — as opposed to individual stocks. With funds, like exchange-traded funds, you're spreading out your risk across securities.
Have an emergency fund
When you're considering where to put money during a recession, keep in mind that you want to have enough cash on hand to weather emergencies like losing your job. Financial advisors tend to recommend holding enough cash to cover around three to six months of expenses, but many suggest having a bit more, if possible, when a recession is expected.
The bottom line? Don’t panic, and stick to your investing plan.
Is a recession coming?
The National Bureau of Economic Research (NBER), a committee that focuses on business cycles, determines when a recession occurs based on a broad-based decline in employment, gross domestic product (GDP), personal income, retail sales and industrial production. The committee has not yet declared that the U.S. is in a recession.
Not everyone is on the same page. According to the Bureau of Economic Analysis, GDP fell 1.6% in the first quarter and 0.6% in the second quarter. GDP then rose at the rate of 2.6% during the third quarter, but two consecutive quarters of negative GDP is widely considered a recession. Some people and organizations, like the Republican House Judiciary Committee, called it a recession.
Again, a recession was not formally declared. But many financial experts predict that one will occur sometime in 2023. Anthony Chan, former chief economist at JPMorgan Chase, for example, says the odds of a recession taking place within the next 18 months are about 90%.
Meanwhile Johnson says a near-term recession in 2023 is more likely than unlikely.
"It will be very difficult for the Fed to engineer a soft landing for the economy and still win the battle to stem inflation,” he says.