As the new year gets into full swing, the possibility of an upcoming recession still looms large and may feel like a big gray cloud hanging over your finances. But it’s not all doom and gloom. There can be ways to protect your portfolio and investments to weather the storm by using some subtle recession-proofing diversification tactics.
You’ve probably heard plenty of people go on and on about diversifying, and for good reason! When the economy and markets are as unpredictable as they are right now, your best bet for staying on top is to diversify wisely. But how should you diversify during a recession?
How a Recession Impacts the Stock Market and Investments
Typically, a recession leads to quieter returns across the board for most stocks and investment asset classes.
Some businesses and securities will still do great. Yet, who comes out on top is never a guarantee. Also, the high inflation and rising interest rates you’re seeing right now will play a role that’s yet to be fully determined and accounted for.
During a recession, investors tend to look for more “secure” options, which sometimes means bonds or Treasury bills. Or dividend-paying stocks that pay out a level of regular income.
This way, if there is little or no growth, investments can still generate a return that you can reinvest or spend. But remember, you don’t have to follow the pack. You can diversify and invest in other ways that suit your outlook and wealth-building goals.
Five Diversification Methods to Use in a Recession
Here are five strategies you can take on board to help with your portfolio if we stumble into a recession.
1. Keep Extra Cash.
Even against a backdrop of high inflation, if you find yourself in the belly of a recession, it’s well worth having some dry powder (cash) on hand.
Over the last hundred years, U.S. recessions have had an average length of just under 13 months. This doesn’t mean you should expect the next recession to last this exact length of time, but it’s a useful guide. Keeping a healthy level of cash throughout a recessionary period can be worthwhile, even if it loses value in the short term.
So, if we end up in a recession, it’s a good idea to keep more cash than you usually would to help ride out the downturn. Diversifying with extra dollars in your back pocket means less chance you’d need to sell investments at a potential loss.
Extra funds at your disposal will also allow you to jump on any great investment opportunities that crop up while everyone else is distracted and miserable.
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2. Use Commodities.
If you don’t keep an allocation of commodities in your portfolio, now might be a good time to consider doing so.
During a recession, the world keeps spinning, and many commodities will still be in high demand. Historically, numerous commodities have performed poorly, but using them as a diversification tool can be a great long-term move. And it’s often best to invest before we hit a full-blown recession and prices rise (because everyone else has the same idea!).
If you’re new to commodity investing, you might consider using ETFs (exchange-traded funds) or managed funds to make things easier for you.
It’s also worth using a mixture of commodities, because you don’t want to be overexposed to a single market. Precious metals like gold can be useful, but be mindful to find a good entry price point, because plenty of investors flock to assets like gold during a recession — which can bump up prices.
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3. Think Outside the Box.
A recession is an excellent opportunity to get creative with your investment portfolio.
Most of the time, you’ll want to focus on protecting your wealth rather than looking for big gains when growth is slow, because those high returns become increasingly challenging to find!
Yet, there can still be opportunities out there. Picking the investment options that will be successful is the hard part. But, if you use this time to diversify and look into investment opportunities that other people are overlooking, it can boost your chances of making long-term gains.
It’s worth diving deeper into assets such as:
- Currencies
- Art and antiques
- Classic cars
- Whiskey and wine
- Music royalties
- Real estate (perhaps using a REIT)
The list goes on. Searching outside the obvious means you might find some hidden gems. You may even pick up a new hobby related to an alternative investment category that keeps you occupied throughout an economic slowdown.
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4. Look for Recession-Proof Stocks.
Some people make this sound easy. The truth is, it can be pretty difficult. But it’s not impossible.
Life carries on during a recession, and plenty of businesses will still make money. Finding the stocks that will perform best can be tricky. Your best bet is to look at what’s worked in the past, then adapt these picks to your investment strategy and the current economic climate.
Each recession is different. So don’t expect things to go exactly the same as in other years. However, you can still learn lessons. Some previously recession-resistant industries and sectors include the likes of:
- Consumer staples
- Health care
- Energy and utilities
- Groceries
- Discount retailers
Remember that no one has a crystal ball to predict the future. Spreading your bets across areas that have performed well previously is definitely a good place to start.
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5. Make the Most of Your Accounts.
This way of diversifying is a bonus. It’s important to use your full range of investing options during a recession, but it’s also vital that you make the most of all the accounts at your disposal.
This means making the most of any tax-advantaged investing and retirement accounts that are tax-deferred or tax-exempt, including:
- Tax-exempt: Roth IRAs and Roth 401(k) plans.
- Tax-deferred: Traditional IRAs and 401(k) plans.
During a recession, it’s worth grabbing any low-hanging fruit that you can. Before you dive into any complex methods of diversification, be sure to take care of the basics and your foundations.
Along with maxing out any easy wins with tax advantages, it’s also worth reviewing your current brokerage or investment platform. Make sure that the costs are reasonable and that you have decent access to a variety of investing options.
Of course, it’s helpful to know how to diversify during a recession, but keep in mind — it’s wasted energy if your stock brokerage doesn't let you invest in a wide selection of assets, or they charge you high fees for doing so!
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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