Recessions are a part of the business cycle. They occur periodically and can impact the financial markets. Some investments may hold up better during these periods than others.
We are not suggesting that you change your investment strategy in anticipation of a recession. Most investors are poor forecasters of changes in the markets and in economic cycles. Over the long haul you may be better off with a diversified portfolio based upon your longer-term objectives and risk tolerance, and you should consult with your financial adviser before making any adjustments to your portfolio.
That all said, here are some investments that may be appropriate during a recession.
8 Things to Invest in During a Recession
Defensive stocks are those stocks whose dividend payouts and earnings tend to be more stable during an economic downturn than cyclical stocks. Defensive stocks tend to be the stocks of those companies whose products and services are needed regardless of the state of the economy. Some examples might be utilities, or basic items like soap, shampoo, and other personal hygiene items. People still need to take care of themselves, use electricity and heat their homes.
Stocks of companies that pay dividends will often hold up better during recessions and stock market corrections than many other stocks. Stocks that pay dividends are often well-established companies with the cash flow to continue making these payments during economic recessions.
Dividend investors might look at dividend-paying stocks as a source of income. Assembling a number of consistent dividend-paying stocks can enhance an investor's income.
Another approach to investing in dividend-paying stocks is dividend growth. Dividend aristocrats are a group of stocks within the S&P 500 that have not only paid dividends for at least the past 25 years, but they have also increased their dividend payout each year over that period. The focus here is not so much on yield, but on dividend growth as a sign of solid management and business growth and stability.
Dividend-paying stocks can be a source of stability during a recession. Investors should remember that these are still stocks and carry the risks inherent in investing in stocks. There are funds that invest in both higher yielding stocks and dividend growth stocks, offering the advantages of professional management and a degree of diversification.
Treasury securities are debt obligations of the U.S. government, issued by the U.S. Treasury. They are often used in financial models as the proxy for a risk-free asset. Treasuries are subject to interest rate risk just as with any other type of fixed income vehicle. Treasuries range in maturity from very short-term Treasury Bills (T-Bills) to longer-term bonds.
Treasuries are riskless in terms of default risk as they are guaranteed by the full faith and credit of the U.S. Treasury. Like any bond, interest payments are made periodically and then the face amount of the security is repaid upon maturity. Some Treasuries are zero-coupon which means that there are no interest payments made, rather the securities are purchased at a discount with the full face value paid upon maturity. Treasuries can be purchased directly from the Treasury via periodic auctions and via the secondary market. There are also a number of mutual funds that invest in Treasuries.
Municipal bonds or muni bonds are issued by state and local governments. They are secured either by the state or the municipality, or in some cases by a specific project undertaken by the issuer. Muni bonds are tax-exempt for federal income tax purposes and in some cases holders in the state of issuance may be exempt for state taxes on the interest received.
Municipal bonds are generally safe, but you will want to be sure that you check the financials and creditworthiness of the issuer before buying any direct issue. The bankruptcy in Detroit several years ago is a reminder that these bonds can carry default risk. Buying muni bonds via a mutual fund can help spread this risk among a number of bonds and offer investors the advantages of a professionally managed fund.
Money Market Funds
Money market funds invest in cash equivalents and other short-term instruments. Typical holdings might include:
- Certificates of deposit (CDs)
- Commercial paper
- Banker's acceptances
- Repurchase agreements
Money market funds pay a rate of interest that will adjust to market conditions. Many money market funds will maintain a fixed net asset value (NAV) of $1, your return is the interest earned. Money market funds are generally very low risk.
Since the financial crisis, the rules surrounding some types of money market funds have changed, in some cases the fund can allow the NAV to fluctuate and they can also restrict access if financial conditions dictate.
Short-Term Bond Funds
Short-term bond funds invest in bonds with shorter maturities. By virtue of their shorter maturities, they have less risk than bonds with longer times until maturity.
Short-term bonds can still carry risk if the issuer experiences financial problems causing them to default on interest payments or be unable to pay bond holders upon redemption; it's important to buy bonds from quality issuers. For this and other reasons, it may make sense to go the mutual fund or ETF route when looking to invest in short-term bonds.
Certificates of Deposit (CDs)
CDs are savings accounts offered by banks and other financial institutions that offer a specified interest rate for a set period of time. Generally, there is a penalty for early withdrawal.
Bank CDs are FDIC insured, making them a low-risk investment during a recession or any type of economic environment. One strategy might be to ladder a number of CDs with different maturities to have funds available over several time frames.
Balanced funds are mutual funds whose portfolios are balanced between stocks and bonds. The allocation might be 60/40 stocks to bonds, 40/60 or some other variation.
The theory behind these funds is that when the stock portion of the fund may be doing poorly, the bonds will hold up a bit better. These funds tend to be lower risk than a pure stock, or a pure stock fund, which can help during a recession.
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