Recessions happen – they’re unavoidable. In fact, they’re a normal part of the economic cycle, just a fact of life. Unfortunately, these economic dips usually send investors into panic mode, racing to get out of the markets before their portfolios hit rock bottom … and that can be a huge financial mistake.
Recessions don’t have to mean big losses.
If you create a plan to get you through the down times (rather than responding emotionally like the vast majority of people), you can substantially limit your losses — and possibly reap some gains — even during a recession.
A recession is an extended period (usually at least six months) of economic decline – meaning the most important financial measures decline. Employment drops, incomes start to fall, retail sales tank, and consumer confidence disappears.
That’s all wrapped up in the big measure (at least according to economists): a negative GDP (gross domestic product) growth rate. The GDP measures a country’s entire economy, and its growth rate lets you know how fast or slow the economy is growing. When that rate goes negative, it means the economy is shrinking … a recession.
- Don’t panic
The absolute best thing you can do for your portfolio in a recession is to stay calm and follow your plan. Making emotional (irrational, impulsive) decisions won’t do your nest egg any good. Keeping a cool head and making logical, strictly financial investment choices will put your finances in the best position to bounce back once the recession gives way to recovery – and it definitely will, it’s just a matter of time.
Even if you need the money very soon (you’re already in or nearing retirement, for example), remember that you don’t need all of it right away. The fear of loss (and financial ruin) can be much stronger in this situation, making it even harder to quiet the impulse to make unplanned moves.
- Think long-term, big picture
Can’t stress this enough: Just like recession is a part of every economic cycle, so is recovery. Your portfolio value will go down, and then begin to rebound, as long as you stick with it. If you don’t need all of your money in the next couple years, you can ride the economic cycle wave back to prosperity. Trying to time your way in and out of investments will likely decimate your finances, so don’t do it. Selling your holdings locks in your losses, and you can keep paper losses from turning into real ones by not selling anything you don’t absolutely have to sell.
If you will need all or some of your money sooner, or if your risk tolerance (how well you handle market drops) is practically non-existent, check out #4.
- Stick with your solid stocks
High-quality companies with proven track records can weather economic downturns. They’ve done it before, they’ll do it again. Companies with plenty of assets, minimal debt, and healthy cash flows will fare much better in a recession than companies with tons of debt and weak cash flows. (This works the exact same way as it does for your household: You have a better chance of making it through tough financial times if you have an emergency fund, limited debt, and enough money coming in to cover the bills.)
So if you’ve already invested in these solid companies, leave your money where it is.
- Reduce your portfolio risk
Shrinking returns and decreasing portfolio values can be stressful and scary … especially if you need that money soon. If you’re starting to get a bad feeling about the economy, and can’t stomach even a temporary drop in your investments, there are things you can do to reduce your portfolio’s risk level.
- Spread out: Diversification across and within investment types can be even more crucial during an economic downturn, helping limit losses and open opportunities for returns. That means holding at least a few different types of assets (which include stocks, bonds, real estate, commodities, and cash), and also spreading out your investments in each asset type (for example, holding both large and mid-size company stocks in a wide variety of industries instead of loading up on only S&P 500 funds or tech stocks). Another good diversification trick: Invest a portion of your money in international funds.
- Increase stability: You can reduce your portfolio’s volatility (the wild swings up and down) without sacrificing opportunity. Look for investments with low beta, a measure of their volatility compared to a benchmark (like the S&P 500, for example). Beta measures movement, and a higher beta means the investment price moves around more, while a lower beta indicates more stability. Stability doesn’t mean zero growth … it just means your investment is taking a train instead of hopping on a rollercoaster. One way to do this: look into preferred stock or common stocks that pay steady dividends, as companies offering these tend to be more stable.
- Downshift the risk factor: Moving money from more risky to less risky holdings will make your portfolio safer from losses, but it will (virtually always) also lower the potential growth and returns. High-quality bonds, money market funds, and cash (anything from CDs to FDIC-insured savings accounts) are safer places to park your money than stocks (even stock funds). That said, it’s a risky move to get rid of all of your riskier investments, because those safe investments typically won’t earn enough to cover inflation as the cost of living increases.
- Scoop up bargains
If you have a habit of making small, frequent investments (like through automated contributions to your retirement plan or to a regular investment account), keep doing that. This style is called dollar cost averaging, and it helps you buy up more shares when stock prices are down. At the same time, continue reinvesting your earnings (like dividends) to take advantage of lower share prices.
You can also accumulate extra shares in solid companies or funds by simply buying them when prices dip. Don’t try to time your purchases – just swoop in and pick up shares when their price drops low enough for you, and expect it that price to keep dropping until the economy starts recovering. You’ve still bought good companies for bargain prices, and you’ll benefit from their price rebound.
- Stick with staples
No matter what’s going on in the economy, people need to eat, use toothpaste and toilet paper, wash their clothes, and heat or cool their homes. And while they may shy away from bigger-ticket luxuries, they won’t give up the things that get them through the day, like coffee, beer or wine, and chocolate. Investing in the companies that supply these necessities offer up some protection (smaller losses, and possibly even some gains) when the economy and the stock market go into a downslide. You can easily find low-cost mutual funds and ETFs that focus on these “crash-proof” holdings through investment companies like Vanguard and iShares.
The most important takeaway here is this: Make a plan and stick with it. If you’re not sure which things to do or how to do them, talk to a financial professional. Ask a lot of questions, and be clear about your overall financial situation and personal risk tolerance.
Once your plan is in place, don’t obsess about your portfolio or the markets in general. You have a solid strategy. Values will go up and down. Sticking with your plan even when values drop uncomfortably low is the best way to make sure your portfolio will be able to rebound when economy does.