Economic recessions are characterized by significant declines in various economic indicators, including factors such as income, employment, production, wholesale retail sales, and corporate profits. As a result, these downturns often lead to declines in the stock market, making the task of managing your investment portfolio particularly challenging. However, there are strategies that can help you deal effectively with this situation.
Invest According to Your Risk Appetite
Investing your funds during a recession, or any other time, should align with your risk tolerance. This factor determines your overall investment style, whether you lean towards a more aggressive or conservative approach.
Investors who favor the aggressive approach prioritize growth and demonstrate an understanding of volatility and a willingness to embrace it. These investors are often prepared to take on more risk and may not be overly concerned about liquidity constraints. On the other hand, those who are more conservative value principal or capital preservation, and may accept lower returns.
Stick to the Plan
While short-term discomfort is an inevitable aspect of recessions, practicing patience during these downturns typically paves the way for substantial long-term gains. A strategic investment approach can help you stay the course. This method takes a long-term view, with a horizon of ten years or more. It is often used to fund distant goals such as retirement or education expenses down the road.
With this strategy, you systematically allocate your resources to various asset classes based on your risk tolerance. These asset classes include stocks, bonds, real estate, and more. Different models are categorized as aggressive, moderate, or conservative. For example, an "aggressive" model might consist of an 80% allocation to stocks and 20% to bonds, while a conservative model might entail a 20% allocation to stocks and 80% to bonds.
Rebalance or Diversify Your Portfolio
To keep your portfolio on track, you may need to rebalance periodically. This involves selling certain investments and buying others to maintain your desired allocation.
For example, suppose your plan initially calls for an equal split between stocks and bonds (50% each). However, due to the performance of the stock market, the value of your stocks has outpaced that of your bonds, leaving your portfolio skewed at 70% stocks and 30% bonds. In such a scenario, you might decide to sell some stocks and buy additional bonds to bring the balance back to your desired 50-50 ratio.
In addition, your financial goals may evolve, or you may discover that your risk tolerance is different than you originally thought. As a result, you might add bonds to create a more conservative portfolio model. Conversely, if you find that you are comfortable with more volatility and risk, you could add more stocks.
Explore Tactical Investment Approaches
Suppose your long-term investment strategy calls for a 60% allocation to stocks and 40% to bonds. Even within this framework, you retain the flexibility to adjust your portfolio to take advantage of opportunities or mitigate risk. Unlike strategic investing, tactical investing responds dynamically to market conditions.
A prudent tactic is to adhere to the business cycle framework, which includes four phases: expansion, peak, recession, and recovery. Different sectors tend to excel during different parts of this cycle. For example, during a recession, consumer staples (such as food and clothing), health care, and utilities often show resilience. On the other hand, during the recovery phase, real estate, consumer discretionary, and industrial stocks often outperform other segments.
Build a Financial Safety Net
If you're new to investing, the first step is to build a cash reserve or emergency fund. This safety net should ideally cover three to six months of your salary. By having such a reserve, you won't be forced to liquidate investments to meet unforeseen financial needs during a recession. Over time, as your investments grow, your cash reserve could also serve as a means to take advantage of market opportunities that may arise in the future.
When recessions occur, remember that every economic downturn eventually ends - with some recovering more quickly than others. The past also serves as a reminder that every recession is followed by a period of economic progress and growth. Even in the midst of the most difficult moments, circumstances can change quickly, so keep your eye on the future.