It’s easy for investors to feel invincible during an economic boom. The problem is that this can lead investors to think that nothing can ever go wrong, and there’s no risk of losing all their money. But as we’ve seen over the past four months, things can change in an instant.
Technically, we are in a recession right now, primarily driven by the novel coronavirus. And there’s no telling how long this recession could last, what its eventual impacts will be, and how the market will be impacted.
So, if you’ve made investments recently or intend to make investments in the coming months, you’ll need to find out how you can better manage your investment risk to avoid losing money during a recession like the one we’re in.
In this article, we will provide you with some useful tips about how to invest during a recession. So, let’s get started.
How to Minimize Your Investment Risk During a Recession
As soon as investors hear words such as a recession or economic downturn, their fears start to kick in. However, they still wait for news about declining stock prices to come in.
When this happens, most investors don’t waste a second to pull their money out of stocks and reallocate it to bonds; this is because bonds are an extremely low-risk investment.
Unfortunately, most people don’t know how to invest during a recession.
While investors avoid losing a whole lot of money by reallocating their funds to bonds during a recession, they are not profiting either. This kills the entire idea of making investments.
So, what should investors do then?
They should use the following ways to minimize their investment risk during a recession instead of simply reallocating funds to low-risk investments.
1. Determine the Amount of Risk That You Can Realistically Take On
You need to consider three things to arrive at the risk that you can realistically take on:
- Your job security
- Your investment horizon
- Your behavior toward risk
For example, you should have a small number of high-risk assets in your portfolio if you’re nearing retirement. On the other hand, you can take on more high-risk investments if you’re in your 20s.
2. Invest in Stocks of the Core Sectors
It is easy to ditch stocks during a recession. However, experts recommend that altogether avoiding equities during an economic downturn is not a good idea.
While the rest of the economy is going through a turbulent time, some sectors continue to grow despite the recession and as a result, ensure steady returns for investors.
Therefore, if you want to protect and grow your investment portfolio during a recession without ditching stocks, then you should contemplate investing in shares of core sectors such as consumer goods, utilities, and healthcare.
Recession or no recession, people will continue to spend money on food, electricity, household items, and healthcare. This means that the above-mentioned core sectors will continue to be profitable and in turn, will continue to provide their investors with an investment payout.
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3. Diversify Your Portfolio
Diversifying your portfolio is always an excellent way to minimize your investment risk, including during a recession. Diversifying your portfolio means having a combination of stocks and bonds in your investment portfolio.
While there is a certain amount of risk associated with stock investments during a recession, this is compensated by the high expected returns offered by stocks. On the other hand, bonds provide a minimal gain, but they are a low-risk investment and thus make your investment portfolio less volatile.
The lure of significant returns on stock makes many people make bad investment decisions. For example, some people will invest all their money in a single share with massive profits. This is a big mistake since they could go bankrupt if the company offering the stock went bust.
The best way to avoid this is by diversifying your portfolio. This means that a wide range of asset classes should make up your investment portfolio, including bonds and stocks. This will help you lower your investment risk during a recession.
Related: How to Avoid Over-Diversifying Your Portfolio
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4. Consider Dividend Stock Investments
One of the best ways to generate passive income is by making dividend stock investments. If you’re going to invest in dividend stocks during a recession, then make sure you invest in companies with strong balance sheets and low debt-to-equity ratios.
If you haven’t previously made dividend stock investments, then an excellent way to start would be looking into dividend aristocrats; these are companies with dividend payouts that have only increased for a consecutive period of twenty-five or more years.
5. Avoid Picking Individual Stocks
A mistake that people make during a recession and at other times is picking individual stocks for investment; they also try to time the market and find the best-performing actively managed shares.
All of these are “don’ts” of stock investing during an economic downturn.
What investors should be doing instead is selecting a diversified portfolio of passively managed assets comprising of both stock and bond and then sticking with it.
This is a better option than picking high-performing individual stocks since the past performance of a stock does not guarantee the same performance in the future.
6. Invest in Real Estate
As seen during the Great Recession of the late 2000s, one of the sectors that can suffer significantly from a recession is real estate.
While a recession is bad news for real estate investors who’ve made investments in real estate prior to it happening, it can be an excellent opportunity for future investors to earn a steady income.
If you’ve been saving up to make investments in real estate for some years now, then it’s best that you delay making that investment until a recession or economic downturn takes place. This is because real estate prices tend to drop during a recession, and you can buy a property for much lower than its price during times of stability.
For example, if you’ve identified a property in your area that costs $200,000, then the price of the property could drop to $150,000 during a recession.
If you already have $200,000 in your bank for buying the property, then you can keep the additional $50,000 as savings or invest it in other assets.
As for the house or property you buy, you can rent it out to a reliable tenant for a year or two to earn a steady rental income from the property. The recession is likely to end by the time the tenancy contract expires, and property prices would have gone up once again.
You can then sell the house for a profit. This way, you make money from both the rental and sale of the property.
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7. Continue Contributing Money Towards Your Investments
Even though a recession has hit the economy, you shouldn’t stop making money contributions to your investments. Contribute as much to your investments as you can realistically afford.
If you don’t do this, then you will encounter financial problems when you retire. Sadly, this is the situation of most Americans today, as Stanford reports that most Americans are not saving enough for retirement.
It is in your interest to not follow the herd and regularly add money to your investments.
8. Check Your Credit Score and Clean It Up If Needed
If your credit score is poor, then it can take several months or even years to set it right. However, the effort is worth it since you will be able to borrow at lower prices by improving your credit score.
For example, during a recession, mortgage rates drop. If you have a good credit score, then you can take advantage of this by refinancing your mortgage and pay a lower fee to buy a home.
Don’t wait for a recession to start improving your credit score. Instead, begin removing the blemishes in your credit score now.
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While all of us would not want to see a recession in our lives again, it is almost inevitable that a recession will occur again while we’re still alive. This is especially true for those younger than 50.
Therefore, it’s best that you start preparing for a recession today, and one of the ways to do that is by improving your credit score.
9. Invest in Large-Cap Funds
If you are a risk-taker and want to continue investing in stocks even during a recession, then make sure that you invest in large-cap stocks instead of small-cap stocks.
What are large-cap stocks?
These are stocks of large enterprises with an international presence. Compared to the smaller companies, these large corps are better positioned to deal with a slowdown in the economy during a recession. This makes their investors less adverse to risk or loss of money.
By reallocating your stock funds from multiple smaller companies to a few bigger companies with larger capital, you will protect your investment portfolio during times of a declining stock market without having to leave the market altogether.
10. Invest in U.S Treasury Notes
If you’re seriously concerned about losing all your money in stocks during a recession, then one of the best things you can do to protect your investment portfolio is to reallocate this money to U.S. Treasury notes.
This is one of the safest ways to invest your money during a recession. While the return isn’t all that great, you at least have the surety that you won’t lose your money and will add some amount to your investment portfolio even if it is a small amount.
However, don’t rush to invest in U.S. Treasury notes during a recession. Instead, wait for stocks to drop by 10% or more before making this decision.
An example of investments in U.S. treasury notes is Vanguard Intermediate-Term Fund (VITF).
Summary
One of the trickiest times to invest is during a recession. This is because markets constantly fluctuate during a recession, and you’re never sure how a market will behave on a particular day.
This increases the risk of investment greatly and people are left wondering where to invest their money to minimize loss and earn a profit. The good news for all such people is that we have identified ten ways above in which they can reduce their investment risk during a recession to avoid going bust.
