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A looming recession—or even talk of one—may have you rethinking your investment strategy. While it's important to avoid rash decisions and significant adjustments to how you manage your investment portfolio, there are some changes you can make that can help you weather an economic downturn a little better than if you were to do nothing.
What Is a Recession?
A recession occurs when a country's economy experiences a significant decline in economic activity. Economists use a nation's gross domestic product—the total monetary value of all final goods and services produced within the country's borders—as an indicator but also look at unemployment, retail sales, income and manufacturing over several months to determine the state of an economy.
Expansion and recession are natural parts of the economic cycle. Since 1945, the U.S. has experienced 13 recessions. In most cases, they're short-lived, with only three of those 13 lasting more than one year and none lasting more than 18 months.
Regardless of how long they last, though, they have the potential to affect your investment portfolio. The stock market is partly based on expectations of the economy over the next six months to a year, so even speculation of a recession can cause stock prices to take a hit.
But not all stocks behave the same during recessions. For example, because consumers typically cut back on discretionary spending during a downturn, companies that sell products and services that consumers need every day tend to perform better than companies that offer discretionary and luxury products and services. Health care and utility companies also typically do well.
Additionally, certain types of assets, such as real estate or precious metals, may do better than others. With enough research or an experienced financial advisor on your side, you may be able to make some minor adjustments to protect your portfolio.
Is a Recession the Best Time to Make Investment Adjustments?
Trying to time the market is generally not the best approach to investing because short-term fluctuations make it impossible to know exactly how the market is going to perform.
Historically, however, some investment opportunities perform better than others during an economic downturn. As long as you're not letting emotion dictate your decisions, small adjustments, such as rebalancing and diversifying your portfolio, can help.
Your time horizon—essentially when you need the money—is another important factor to consider. If you're in your 30s and your investments are primarily for retirement, short-term volatility caused by a recession won't have a huge impact on your portfolio in the long run.
In this case, you could make some minor adjustments to your strategy, but you'd also likely be fine making no changes at all with the expectation that they'll be worth the same on the other side. If you can afford it and your risk tolerance is high, you may even want to pump more money into your investment accounts during downturns to take advantage of "cheaper" prices.
If you're planning to retire in the next few years, the short-term impact of a recession could be devastating to your plans, so it may make more sense to do what you can to preserve the wealth you've accumulated by shifting your money toward safer investments, such as bonds, money market mutual funds or cash.
If you're investing in a taxable brokerage account, cashing out could be worth considering if you need that money for emergencies. But if you have a robust emergency fund and don't need your investment funds for anything in particular, it's best to avoid selling everything off.
How Can You Help Your Investments Weather a Recession?
Depending on your situation, the right approach to making sure your investments come through a recession intact can vary. The most important thing is to avoid making rash decisions based on fear. If you're worried about making emotional decisions about your money, consider consulting with a financial advisor who can give you objective advice based on your situation and goals.
With that in mind, here are some potential steps you can take:
- Rebalance your portfolio. It's natural for your portfolio to get out of balance over time. If you wanted 80% of your money in stocks and 20% in bonds, for instance, market performance within those asset classes over several months can alter their value and knock that balance out of alignment. That's especially true during a recession. Rebalancing, which is a service many brokers provide, can help you adjust your asset allocation to match your original goal.
- Follow the news. Not all recessions are created equal, so it's important to understand what's happening. While the real estate market took a catastrophic blow during the Great Recession in the late 2000s, that's not necessarily going to be the case again. Spend time reading about how the downturn is affecting individual industries and asset classes to better inform your decisions.
- Focus on assets that generally perform well. It's true that every recession is unique. But as mentioned above, some asset classes and stock sectors tend to perform better during economic downturns than others. While you may not want to move all of your money into those investments, minor adjustments to your portfolio to incorporate them can help improve diversification, thereby reducing risk.
- Consider your individual situation and goals. While some decisions may be good for other investors, they may not be the right fit for your current situation, your goals and your time horizon. Focus on the strategy that works best for you.
- Consult with a professional. Developing an investment strategy can be incredibly complicated. If you're feeling out of your depth or want validation for your decisions, consider working with a financial advisor. While they don't work for free, they can provide valuable advice that can help you accomplish your goals.
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Don't Ignore Other Aspects of Your Financial Plan
During a recession, it can be easy to focus on investing, but an economic downturn can also affect other aspects of your financial plan. If inflation is out of control, for instance, you'll want to look at your budget and adjust your spending to avoid letting your expenses outpace your income.
You'll also want to evaluate your emergency savings and insurance coverages to make sure you're covered in the event of a medical crisis, unemployment, a disability, a death or other events that could cripple you financially.
Finally, be sure to monitor your credit regularly. If a recession puts a strain on your budget, it can cause you to rely more on debt and potentially miss some payments, which could have a serious impact on your credit score. Additionally, you'll want to watch out for signs of identity theft, which can increase during periods of economic recession.
As you take a holistic approach to shoring up your finances during difficult economic times, you'll have a much better chance of avoiding the worst of it.