How Should a Slow Economy Affect My Investment Strategy?
Use these investment tips to weather a slowing economy
When the economy slows, often known as the late cycle of the overall business cycle, you may wonder which investing strategy to adopt. While an economic slowdown is marked by positive growth at a slower pace, and is different from the economic shrinkage that occurs during a recession, it can still make investors jumpy enough to lose sight of their financial goals and abandon their investment approach.
However, it's important not be scared off by an economic slowdown. There are certain investment strategies you can take to preserve your portfolio during an economic slowdown so that it is poised for future growth.
When the economy slows, it's important not to panic and pull money from your investments, especially if they are at a low. No damage will be done to your bottom line unless you sell an investment a loss. If you sell at a loss, you lose money, potentially a lot of it. Your best bet is to keep your money where it is and wait for prices to go back up—and they generally speaking, they do go up, so you will likely make money in the stock market over the long term despite a slowdown.
The stock market has grown through 10 complete business cycles, and despite the volatility of stocks in the late cycle, they are still likely to grow moderately during a slowdown. This is why experts generally recommend that you stay invested when the economy slows to stay on track with your financial goals.
In fact, when the economy slows, it's actually a great time to buy stocks since they're more likely to remain steady in price or rise in price at a less rapid rate, which gives you time to get in on the growth. If you can afford to invest, seek out companies with a track record of growth and innovation; a slowdown is unlikely to limit their future growth, which increases the odds that you will reap future returns when the economy bounces back.
You should only be investing money that you can afford to lose and are willing to leave alone for a few or even several years, depending on your investment strategy.
Hold a Mix of Different Assets
Asset allocation involves deciding on the mix of asset classes to hold in your portfolio, such as stocks, bonds, and cash.
All asset classes tend to exhibit mixed a performance during the late cycle that is generally lower than that during other expansion phases of the economy. However, stocks tend to perform better in certain metrics, and cash usually does better than bonds. Still, experts generally recommend that you maintain a mix of stocks, bonds, and other investments during an economic slowdown.
Maintain Diversification Across Industries
Once you've settled on the ideal asset allocation, it's a good idea to diversify your investments in preparation for a slowdown. Diversification involves spreading your money across investments in a way that limits losses but leaves open the potential for future gains.
You do not want to have all of your money in one industry, or company. For example, you don't want your portfolio to only represent the tech sector, because if that industry takes a hit, so will your portfolio. You might choose investments using the sector rotation strategy, whereby you increase your allocations in industries projected to do well during a given phase of the business cycle and reduce allocations to underperforming industries so that your portfolio performs better than the market. The materials, health care, and energy sectors tend to perform well during the late cycle of the economy.
You may also want to consider including real estate in your portfolio. Though it requires more cash up front, real estate can be a great source of supplemental income that can offset lower returns on investments in other industries during an economic slowdown. It can help you accumulate wealth over time and could even become your main source of income.
Try to purchase your rental properties with cash or be sure that you can afford the cost of a second mortgage even if you are not able to rent your place out. It is extremely important to realize the financial responsibility that comes with owning real estate and to plan your finances accordingly.
Maintain Holdings in Many Companies
Even if a variety of high-performing industries are represented in your portfolio, it's important not to put all your money into a select few companies or a single company, no matter how well it has performed in the past.
An easy way to diversify your portfolio is to purchase varied mutual funds that already spread the risk over several different companies. But if you buy individual stocks, prioritize firms with a history of stable earnings and strong balance sheets that have more assets than liabilities. With bonds, you may want to increase your portfolio's tilt toward bonds and treasuries with good credit ratings. Inflation-protected bonds and commodities have also been shown to perform well during the late cycle.
Talk to your financial planner to formulate your investment strategy. They should be able to recommend investments that match your investment timeline and financial goals.
The Bottom Line
During an economic slowdown, it's important to understand your investments. Take the time to talk to your financial planner about the types of investments you hold and the risks associated with each. But keep your money invested; don't panic if your investments don't grow at the rate they once did or pull out your money under the presumption that you will do damage to your portfolio. The stock market is cyclical, and most of the time, your portfolio will increase in value again.
Likewise, while it's useful to check in on your portfolio on occasion so that you have a general idea of how it is performing during a slowdown, it may not be helpful to obsess over its value every day. When you invest in the stock market, you have to ride out the tough times in order to come out ahead.
If you find yourself in a slow economy, it's also a good time to assess your current financial habits and your budget and make adjustments as needed. A slow economy highlights the importance of good financial habits, such as spending within your means.
When the economy—and the stock market—begins to trend upward again, continue to be vigilant about your finances and investment portfolio and remember the financial lessons you learned during the slowdown.
Updated by Rachel Morgan Cautero.