Rising interest rates, record-breaking inflation, an inverted yield curve, and ongoing supply chain issues all point to the possibility of a recession.
While this might be cause for concern, it's good to remember that the economy constantly fluctuates, and a slight downturn doesn't necessarily predict a full-blown recession.
However, if you haven't already, statistics say you will experience at least one recession in your lifetime. In the event of a downturn, crossing your fingers and hoping for the best or making financial decisions under duress is never a good idea.
An impending recession is an excellent time to evaluate your investments and discover how to build a recession-proof portfolio.
What is a Recession?
The official diagnosis of a recession is a pronounced decline in the economy that lasts at least two consecutive quarters. Measured by a drop in gross domestic product (GDP), it typically affects employment, manufacturing, retail sales, and consumer income.
Many things can trigger a recession, but typically, an economic imbalance is to blame. External factors such as the Ukraine war, a decrease in consumer spending thanks to inflation, or a burst in the housing market bubble can also instigate a recession.
A recession is often accompanied by a bear market, defined as a 20% decline in the stock market.
At the start of a recession, consumers will spend less on nonessential products and services, creating a domino effect that negatively impacts economic growth. Many businesses will slow down as revenue declines, and they may tighten payroll for fear of what's to come.
Some economists believe a recession is in motion or has even ended before the National Bureau of Economic Research (NBER) declares we were in a recession.
How a Recession Impacts Financial Markets
Because many investors panic at the first sign of a recession and liquidate assets, financial markets can spiral quickly.
Stock prices decrease when investors ditch them for lower volatility options like government bonds. Job layoffs force homeowners to sell their property well below market value causing real estate to devalue. And cuts to consumer spending can affect investments in nonessential businesses.
The good news is that not all industries are negatively impacted by a recession, and some sectors even thrive. More cyclical industries, like travel and luxury clothing, will experience a decline. At the same time, other essential consumer staples like food and health care might even grow.
Because it's difficult to predict when a recession will hit and how extreme it will be, the best thing you can do to survive one with minimal impact is to build a recession-resistant portfolio.
What is a Recession-Proof Portfolio?
Fluctuations in the stock market are inevitable. Businesses in all sectors experience natural ebbs and flows as the economy expands and contracts.
But during a recession, nonessential businesses are hit the hardest. These are referred to as cyclical businesses because their value relies on consumer spending.
On the flip side, industries that sell essential products and services like food, electricity, and healthcare experience better insulation during an economic downturn. These industries are considered recession-proof as they're stable and have even performed better during recessions in the past.
One of the best things you can do to recession-proof your portfolio is to diversify your investment. Including stocks that historically perform better during a recession is a good start.
Keep in mind that there are pros and cons to a recession-proof portfolio. It's essential to maintain some balance and not only focus on assets that will perform well during a recession. Certain high-growth stocks may perform well in the short term but underperform during economic expansion.
How to Recession-Proof Your Portfolio
Before you make any moves to recession-proof your portfolio, it's a good idea to check the current climate. In the middle of a recession, it might be good to hold off on updating your asset allocation until the economy is less volatile.
The good news is, whatever your risk tolerance, you don't need to lie awake at night and watch your portfolio crash. There are things you can do to protect yourself during an economic downturn.
Diversification of Your Investments
You've heard the saying, don't put all your eggs in one basket. Well, this couldn't be more true when it comes to investing. Sure, there's that one story about that one person who invested in Apple stocks way back when and made it big, but the chances of this happening to you are slim.
Your returns should not be completely reliant on one stock doing well. If you're already in the stock market, look to expand and add high dividend stocks like mutual funds and exchange-traded funds (EFTS) that invest in consumer staple industries like grocery stores and health products. These types of businesses historically outperform cyclical sectors during a recession.
And if you're currently only invested in the public stock market, it's time to stop relying on one investment to fill your basket. Diversification requires you to branch out and invest in other asset classes. Variety is the spice of life, after all.
With an unpredictable market, building diversification into your portfolio is the best way to shield yourself from the volatility of a recession. And unless you're at retirement age, invest for the long term and work towards creating a portfolio that will weather any economic storm.
Invest in Real Estate
Buying up all the real estate during a recession might be tempting. Low prices can flash dollar signs, but it's best to avoid purchasing real estate during a bear market if you don't have much cash.
However, if you already own real estate or can invest in premium markets when prices are at their peak, it will serve you well. While real estate in primary markets might take a slight hit, it will recover its value quickly as the recession passes.
Real estate isn't exactly a liquid asset. But if you aren't over-leveraged and can take out equity from a property, it could safeguard against job loss or other short-term emergencies. You could also use the cash to invest further.
Purchase with caution, though! Not all real estate is equal, and some asset classes will withstand a volatile market more than others.
People will always need a roof over their heads, and rental properties offer passive income and predictable cash flow that a vacation home may not.
Buy Shares in Defensive Sector Funds
Past recessions and the pandemic showed us that some businesses fare better in recessions than others. Companies that meet consumers' basic needs tend to remain stable despite an unstable economy.
Defensive sector funds are mutual funds and EFTS that invest in these recession-proof sectors.
As sales dry up for nonessential businesses like entertainment, high-end clothing, and travel, balance sheets and cash flow remain strong for essential companies. A few examples of these defensive businesses include:
As we know, healthcare is essential. Recession or no recession, people still need medicine, insurance, doctors, and other medical products.
People need food and toilet paper! Eating out can be pricey and tends to get cut from budgets during a recession. Buying groceries is less expensive, adding grocery stores to the list of recession-proof businesses.
Paying a utility bill tops the list of essential services as heat, hot water, and lights are high priority. This also extends to any service involved in building and maintenance infrastructure.
When investing in defensive markets, remember that diversification is still critical. These investments can experience much slower growth and are most effective when you spread your money among them.
According to Warren Buffett, investing is laying out money now to get more money back in the future. High-yield stocks might be exciting in the short term, but they aren't always the best option for the long term, especially if you're into retirement planning. Slow and steady often wins the race.
Consider Precious Metals
People have been enamored with silver and gold since that first shiny rock was discovered thousands of years ago. Because precious metals perform at a mediocre level when the economy is ticking along, many people don't consider these when building a recession-proof portfolio.
When the stock market takes a nosedive, these shiny metals make a valiant comeback. Investors fall back on gold and silver as a safe option when the economy is uncertain, increasing their value.
You can buy literal blocks of gold or invest in funds that own a single precious metal or an eclectic mix of them.
Build An Emergency Fund
Most financial advisors recommend building an emergency fund. If you already have one started, great. If not, it's never too late to start investing in yourself.
You never know what could happen with the economy, even if you're in a solid financial position. Layoffs happen, stocks tank, and an emergency fund will allow you to comfortably get through a recession without panic-cashing in any of your investments.
Retirees are especially susceptible to financial troubles during a bear market. A cash buffer will offer an extra layer of protection should you need to liquidate some assets or if most of your money is in volatile stock and bond investments.
In the event of a looming recession, the best thing you can do is not panic. All investments fluctuate over time, and if you take the steps to recession-proof your portfolio, you can relax and trust that you've made good choices.
Never let your portfolio sit idle, however. Maintain your objectives and ensure they always align with your long-term goals to mitigate any desire to make impulsive decisions.
It's also important to keep things in perspective. Recessions are short-lived, and the economy will recover.
Manage Your Investments with Technology
Now that you know how to build a recession-proof portfolio, you need a way to track your investments. And since you've done a bang-up job with your portfolio diversification, managing all of it can feel overwhelming.
Between real estate, EFTS, precious metals, and defensive sector funds, it can be easy to miss out on investment opportunities or make uninformed decisions about buying or selling stocks.
A holistic approach to managing your portfolio will help to avoid making decisions you might regret. Using technology that places all of your assets at your fingertips will ensure you have accurate information based on real-time updates.
Use Kubera for the Ultimate Recession-Proof Portfolio
A portfolio management software like Kubera tracks all your investments in one place.
Kubera is your personal balance sheet, so you can ditch the spreadsheets and manual tracking. It's easy to load your entire portfolio of assets into Kubera's custom platform as it integrates with thousands of financial institutions.
Simply add all your account-based assets like bank and savings accounts, brokerage profiles, crypto wallets, mortgages, loans, etc., and Kubera updates you in real-time.
With access to your entire portfolio, it's much easier to understand how each asset affects your net worth as a whole rather than individually. Never make a unilateral decision about an investment again.
And the best part?
You can use Kubera on any device. It's compatible with every desktop, iOS, and Android device on the market. Do you work with a financial advisor or wealth manager? Kubera can accommodate that, too, with our white-label solution—a modern client portal for the ultimate experience.
Sign up for your subscription today and enjoy a 14-day free trial. Take the time you need to explore how Kubera works, and discover all the features that will help you get the most out of your recession-proof investment portfolio.