The year 2020 has been a rollercoaster ride for investors. We saw extreme lows in March and extreme highs in August. On June 8, it became official that the U.S. had entered a recession. This came after the longest expansion in the nation’s history, which ended back in February.
Recessions are most often defined by a large decline in activity spread across the economy. They last more than just a few months. During recessions, there are many declines: income; employment; production; and wholesale retail sales, along with corporate profits.
In every past recession, there were job losses, market drops, and other events that tested investor patience. But the markets and the economy eventually stabilized. This was followed by much longer expansion.
But most investors underperform the market. This is even more true during downturns. They may lose more money during those downturns and make less money when the markets recover. Here’s what to do instead when managing your portfolio during a recession.
- Decide your financial goals and their timeframes; then, assess your tolerance for risk and losses.
- No matter where the business cycle is, build your investment plan. Research shows that it doesn't matter when you start investing, as long as you do it systematically.
- Recessions are much shorter than expansions, and patience is usually rewarded. Don’t base your decisions on today’s headlines.
- Take a deep breath, and stay calm. If you still have concerns, revisit your strategy to figure out if it still meets your objectives.
Invest According to Risk Tolerance
How you invest your money during a recession (or any other time) should fit with your investment style: whether you take a more aggressive or conservative approach.
Those who are aggressive value growth; they understand volatility and accept it. They may be willing to take on risk. They may not be concerned about liquidity.
On the other hand, those who are more conservative value principal and may accept lower returns. An aggressive investor may allocate more to U.S. and foreign stocks. But a conservative investor may have a larger allocation to bonds and short-term investments.
An investment plan starts with matching your risk tolerance to your financial goals to the time horizon for achievement. Firms like Fidelity, Vanguard, and others provide portfolios, tools, and resources. If you don't have the time or interest to do the research yourself, think about working with a professional.
Stay the Course
While painful in the short term, patience during recessions usually earn long-term rewards. Strategic investing can help you stay the course. This is a long-term approach with a time frame of 10 or more years. It's often used to fund retirement or education expenses down the road.
With this approach, you systematically plan to allocate money to different asset classes depending on your risk tolerance. These assets may be stocks, bonds, real estate, and more.
Models are billed as aggressive, moderate, or conservative. For instance, an “aggressive” model might have 80% stocks and 20% bonds; a conservative model might have 20% stocks and 80% bonds.
The best time to have an investment plan in place is before recessions. Know what you’re investing for; then, keep that goal in mind.
"Understand volatility and don’t sell low at the bottom,” Wendy Liebowitz, branch leader of the Fidelity Investor Center of Fort Lauderdale, told The Balance via email. “You need to have a certain amount of tolerance to stay through your planned time frame."
If you’re just getting started with investing, don’t worry about when to get started. This is true even if we’re in a recession. Whether the market has just hit fresh highs as it did in August of this year, or the market is at a dismal low like it was in March, research shows that it doesn’t matter when you enter the market. What's more important is that you invest systematically over time.
"Identify your approach and criteria and adhere to it," Leibowitz said.
Rebalance or Diversify Your Portfolio
To keep your portfolio on track, you may need to rebalance. In other words, you might need to sell one type of investment to buy another type.
Let's say your plan calls for 50% stocks and 50% bonds. But the stock values increased more than the value of the bonds in the past year. That put your portfolio at 70% stocks and 30% bonds. In this case, you could sell stocks to buy more bonds to rebalance your portfolio.
Also, your goals may change. Or, you might find out you’re not the risk-taker you thought you were. You could add bonds to create a more conservative portfolio model. If you find you’re able to handle more volatility and risk, you could add stocks.
You can also diversify by adding different types of investments. For instance, a newly retired investor might add real estate for more income.
Look into Tactical Investing
Let's say your longer-term investment plan calls for maintaining 60% stocks and 40% bonds. But you can still change your portfolio to take advantage of opportunities or decrease your risk. In contrast to strategic investing, tactical investing responds to the market.
Consider this method based on the business cycle framework. The business cycle has four phases: expansion, peak, recession, and recovery. Some sectors perform better than others during different parts of the business cycle.
In the midst of a recession, consumer staples (such as food and clothing), health care, and utility stocks tend to be strongest. During the recovery phase, real estate, consumer discretionary, and industrial sector stocks often outperform other sectors.
Aggressive investors might buy stocks in sectors like consumer discretionary. These are goods that people want but don’t need, such as TVs and vacations; they trade below their fair value during a recession because they’re a bargain. These investors are willing to wait for growth until the recovery begins.
On the other hand, less aggressive investors could add stocks that pay dividends. This can help soften the blow of other stock price declines.
Use Dollar-Cost Averaging
Regular contributors to a retirement plan like a 401(k) could consider dollar-cost averaging. This is when you contribute the same amount of money per pay period to each stock, ETF, or mutual fund that you’ve chosen in advance. When share prices are down, you’ll end up buying more shares. When share prices are up, you’ll be buying fewer shares.
The best part? No need to second-guess when the market will be up or down. Over time, the price of the shares will average out.
Build Cash Reserves
If you’re new to investing, first set up a cash reserve. Your cash reserve should be three to six months of your salary. If you need cash for any reason during a recession, you won’t be forced to sell investments to meet the need.
Over time, your investments can grow. And your cash reserve could allow you to take advantage of market opportunities in the future.