Economies naturally grow and contract. When the business cycle is in a sustained period of contraction, otherwise known as a “recession”, market-wide economic activity declines and stock prices typically fall. Since downturns in the business cycle inevitably arise every so often, it’s crucial that you make your investment portfolio as resistant as possible to the effects of a recession.
On April 14, 2020, the International Monetary Fund (IMF) forecasted a global economic contraction of -3.0% by the end of the year. Should the IMF’s prediction materialize, we’re due for a recession that will dwarf the late-2000s global financial crisis. In 2009, during the depths of the financial crisis, the year-on-year change in real GDP growth was only -0.1%.
If you haven’t already, it’s time that you mitigate the effects of the Great Lockdown recession by diversifying your portfolio. To do this, you’ve got to learn the basics of financial risk management.
Risk Management 101
One of the best risk mitigation strategies regardless of the business cycle is to invest in dividend-paying stocks. Investing in dividend stocks provides reliable cash flow which affords a degree of stability during economic contractions. Likewise, dedicating a portion of your portfolio to U.S. Treasury bonds also provide stability because they’re backed by the full faith of the federal government. These assets perform comparatively well during times of instability.
Although no stock is completely recession-proof, there are generally safe investment options to be found in publicly-traded companies that sell basic consumer goods, such as Walmart (WMT), Johnson & Johnson (JNJ), and Dollar Tree (DLTR). Similarly, garbage collection companies like Waste Management (WM) or entertainment companies like Disney (DIS) and Netflix (NFLX) are also relatively safe bets during an economic downturn.
Alternative assets outside of traditional stock and bond markets tend to be strong performers during recessions. For instance, low-fee real estate investment trusts (REITs) provide a relatively low-risk means of investing in real estate for nonaccredited individuals. Likewise, investing in other real assets like precious metals—including gold bullion and gold-backed ETFs—land, and commodities can also hedge against inflation and systemic risk.
Finding the best investments during a recession isn’t a simple task. To make it easier for you, we’ve reviewed some of the best financial newsletters which include lessons on risk and trade management, as well as tips for developing critical money management skills.
Tips for Protecting Your Portfolio
It’s difficult, if not impossible, to reliably predict how the market is going to behave. However, you can hedge against volatility by simply allocating an even share of your portfolio to assets in noncorrelated markets. This way, the risk is evenly spread across a variety of assets. Since it’s unlikely that every asset class loses value simultaneously, spreading your capital across many asset types helps keep risk levels to a minimum.
Although you don’t predict how markets are going to play out, you can, in fact, decide where you want to spread risk. Below, I’ve listed a handful of asset classes that deserve some degree of allocation in your portfolio.
- Large-cap stocks: Equities issued by companies with a market capitalization of $10 billion or more.
- Mid and small-cap stocks: Equities issued by companies with a sub-$10 billion market cap.
- Fixed-income securities: Government or corporate bonds that pay a set interest rate and return the principal investment at maturity.
- Money market: Short-term debt investments, such as Treasury bills.
- REITs: Crowdfunded investments in mortgages or physical real estate.
- Emerging markets: Securities issued by companies in developing states which carry a higher degree of risk.
- Precious metals: Naturally occurring metals such as gold, silver, and platinum, that are economically valuable and serve as stores of wealth.
- Digital assets: Cryptocurrencies and other digital mediums of exchange that incorporate cryptography to secure financial transactions.
Although your portfolio doesn’t have to include each of the asset classes listed above, spreading your wealth across as many assets as possible reduces risk. This is the promise of diversification: allowing investors to maximize returns by investing in a range of assets that respond distinctly to the same economic event.
Start Managing Risk Today
Risk is an unavoidable element of investing, and recessions present one of the most significant systemic risks for investors. Although they cannot be avoided, they can be effectively minimized via diversification. Fortunately, there are plenty of resources available online to help you diversify your portfolio and invest in alternative assets noncorrelated to the stock market.
For example, our review of Noble Gold investments highlights how this precious metals dealer offers a variety of safe-haven assets including platinum and palladium. Investors looking to further diversify their portfolio should check out our Noble Bitcoin review to read about their safe and secure digital asset purchase and storage options.
While no investment portfolio can fully elude the effects of a recession, proper risk management and asset diversification can mitigate any losses incurred. Spreading your capital across various financial instruments and asset classes hedges against systemic risk and the inflationary effects of excess government spending which can protect your wealth in a bear market.