The year 2020 has been a dizzying rollercoaster ride for investors, from March’s lows to August’s highs. On June 8, the National Bureau of Economic Research announced that the U.S. had officially entered a recession after the longest expansion in the nation’s history ended in February.
Recessions are usually defined by a significant decline in economic activity spread across the economy, lasting more than a few months. During recessions, income, employment, industrial production, and wholesale-retail sales decline along with corporate profits.
In every past recession—long or short, mild or severe—there were job losses, market drops, and other events that tested investor patience. But the markets and the economy eventually stabilized, followed by much longer expansion.
Unfortunately, the average investor underperforms the market, especially during downturns and volatile periods. They may lose more money during the downturns and make less money when the markets recover. Here’s what to do instead, when managing your portfolio during a recession.
Invest According to Risk Tolerance
How you invest your money during a recession (or any other time) should be compatible with your investment style along the aggressive-to-conservative continuum. Aggressive investors value growth, understand volatility, and accept it. They may be willing to take on risk, and may not be concerned about liquidity.
On the other hand, conservative investors value principal and may accept lower returns. An aggressive investor may allocate more to U.S. and international stocks, while 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 (such as retirement or college funding) to the time horizon for achievement. Financial services companies like Fidelity, Vanguard, and others provide portfolios, tools, and educational resources for investors to build their plans. If you don't have the time, or the inclination to do the research yourself consider working with a professional financial advisor.
Stay the Course
While painful in the short-term, patience during recessions and volatile markets usually earn long-term rewards. Strategic investing can help you stay the course. Strategic investing is a long-term approach (with a time frame of 10 or more years) often used to fund retirement or education expenses down the road.
With this approach, you systematically plan to allocate money to different asset classes, such as stocks, bonds, and real estate, depending on your risk tolerance. Models are billed as aggressive, moderate, or conservative. For example, an “aggressive” model might have 80% stocks and 20% bonds, while a conservative model might have 20% stocks and 80% bonds.
The best time to have an investment plan in place is before recessions and volatile markets. Know what you’re investing for and 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, Florida, 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 beginning your investment journey, don’t be concerned about when to begin, 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 as long as you invest systematically over time into your preferred model.
"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, or sell one type of investment to buy another investment.
If your plan calls for 50% stocks and 50% bonds, and the stock values increased more than the value of the bonds in the past year, your portfolio may then contain 70% stocks and 30% bonds based on the values. In this case, you could sell stocks to buy more bonds to rebalance your portfolio.
As well, your goals may change—or you might discover 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 your portfolio by adding different types of investments. For example, a newly retired investor might add real estate to the portfolio for more income.
Consider Tactical Investing
Even if your longer-term investment plan calls for maintaining 60% stocks and 40% bonds, you could change your portfolio to take advantage of opportunities, or decrease your risk. In contrast to strategic investing, tactical investing responds to the market.
Consider tactical investments based on the business cycle framework. The business cycle has four phases: expansion, peak, recession, and recovery. Historically, 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 have historically outperformed other sectors.
Aggressive investors might buy stocks in sectors like consumer discretionary (goods that people want but don’t need, such as TVs and vacations) that get "beat up" and 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, which 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, where you contribute the same amount of money per pay period to each stock, ETF, or mutual fund that you’ve selected in advance. When share prices are down, you’ll end up purchasing more shares. When share prices are up, you’ll purchase fewer shares.
The big benefit? No need to second-guess when the market will be up or down during volatile recessionary times. Over time, the price of the shares will average out.
Build Cash Reserves
If you’re new to investing, first establish 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 (such as a major car repair or if you’re laid off) you won’t be forced to sell investments to meet the need.
Over time, as your investments grow, your cash reserve could allow you to take advantage of recession market opportunities.
- Identify your financial goals and their timeframes, and honestly assess your tolerance for risk and losses.
- Regardless of 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 investment strategy to determine if it still meets your objectives.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.