The COVID-19-related recession of 2020 was just two months long, making it the shortest recession on record. Like all recessions, though, it impacted the lives of many. Now, as the economy may be headed into another downturn, it’s a good time to review how to take advantage of the recession instead of letting it take advantage of you.
There were a lot of lessons to be learned for investors, plenty of whom saw their investment accounts devastated by selling in the panic. In some cases, if they had held onto their investments, they would have fully recovered and gone on to increase in value.
The first lesson of a recession is that it is always followed by a recovery that includes a strong rebound in the stock market. The second lesson is that investors do not have to sit idle as their portfolios get pummeled by massive selling. There are some investment strategies that can take advantage of recessionary forces to position a portfolio for a quick and strong rebound.
- Recessions have always been followed by a recovery that includes a strong rebound in the stock market.
- When the market starts to plunge, it is time to take advantage by increasing your contributions to or starting dollar-cost averaging in a non-qualified investment account.
- The best way to own dividend stocks is through mutual funds or exchange-traded funds (ETFs) that invest strictly in dividend-paying companies.
- Consumer staples manufacturers weather recessions well, and there are several options to invest in this area.
1. Use the Dollar-Cost Average When Share Prices Decline
As with most recessions, you probably will not see the next one coming. But you will likely see a sell-off in the stock market well in advance of a recession. When that happens, remember the first lesson: The stock market will usually begin to bottom well before the end of the recession.
Knowing that, investors can take advantage of a declining market through the dollar-cost averaging method of investing. If you make monthly contributions to a qualified retirement plan, you are already using the technique. But when the market starts to plunge, it is time to take advantage by increasing your contributions to or starting dollar-cost averaging in a non-qualified investment account.
When you dollar-cost average your investing, you gradually reduce your overall cost basis in the share price. Then, when the price rebounds, your cost basis will often be lower than the price. For example, if you invest $500 a month in a mutual fund selling for $25, your contribution buys 20 shares. If the share price drops to $20, your contribution buys 25 shares. Your account now has 45 shares with an average cost basis of $22.
As the share price drops, your $500 contribution buys an increasing number of shares and your cost basis continues to drop. When share prices rebound, your contribution buys fewer shares each month, but the current share price is always higher than your cost basis. The dollar-cost averaging method works best over the long term for investors who do not want to worry about how their investments are performing.
If you are going to hold stocks during a recessionary period, the best ones to own are from established, large-cap companies with strong balance sheets and cash flows.
2. Buy into Dividends
If you are going to hold stocks during a recessionary period, the best ones to own are from established, large-cap companies with strong balance sheets and cash flows. Not only are these companies better situated to weather economic downturns than smaller companies with poor cash flows, but they are also more likely to pay dividends.
For investors, dividends serve a few purposes. First, if a company has a long history of paying and increasing dividends, you can have peace of mind that it is financially sound and can survive most economic environments. Second, dividends provide a return cushion. Even as share prices decline, you still receive a return on your investment. It is for these reasons that dividend stocks tend to outperform non-dividend stocks during market downturns.
The best way to own dividend stocks is through mutual funds or exchange-traded funds (ETFs) that invest strictly in dividend-paying companies. Funds that invest in companies with long histories of paying dividends and strong track records of increasing those dividends tend to generate high current yields and capital appreciation when the stock rebounds.
Funds that invest strictly in dividend-paying companies may not outperform the market during market rebounds. This is because these types of funds invest in companies that provide stable returns across different market cycles. Therefore, as the market rebounds, you can gradually allocate away from your dividend funds, but you should always maintain a portion as a defensive measure.
The dividend-adjusted close, or adjusted closing price, takes into account any distributions or corporate actions that occurred between the previous day’s closing price and the next day’s opening price. Dividends lower the value of a stock because profits are distributed to shareholders rather than being invested back into the company.
3. Invest in Consumer Staples
Even during recessions, consumers need to buy food, drugs, hygiene products, and medical supplies. These are consumer staples, which are the last items to be cut from the family budget. So while companies selling high-end electronics and other discretionary products experience drops in revenue, companies selling food products and other basic necessities do not. Because of this, companies in the consumer staples sector are sometimes called defensive stocks, since they tend to remain resilient even when the economy falters.
Data shows that these types of companies outperformed the S&P 500 during the last several recessionary periods. Consumer staple companies include Johnson & Johnson, Procter & Gamble, Conagra, and Walmart. These particular companies also pay good dividends, which strengthens their defensive profile. There are also mutual funds that invest strictly in consumer staple companies. For example, the Fidelity Select Consumer Staples Portfolio invests a minimum of 80% of its assets in companies engaged in the manufacture, sale, or distribution of consumer staples.
What investments do well in a recession?
While there is no guarantee of the performance of any security, so-called defensive stocks, such as those in the consumer staples sector, tend to be resilient during recessionary periods. These companies make, sell, or distribute needed items such as food, drugs, medical supplies, and hygiene products.
What should you not do in a recession?
Financial risks tend to increase during a recession, so it’s best to avoid taking on any new and risky investments or financial commitments. Depending upon your position, industry, and experience, it’s also a good idea not to take your job for granted, or to dip into your savings unless it is necessary.
Where is your money safest during a recession?
Many investors turn to conservative asset classes such as bonds during recessionary periods. Mutual funds may also be a useful area to consider, and so may established, large-cap companies with strong balance sheets and cash flow.
The Bottom Line
Recessions are an inevitable part of being a participant in the financial world. They can be unpredictable and may also have a significant impact on many people. But there are ways to position yourself and your investments to be as prepared as possible for a recession. Focusing in on defensive plays like consumer staples stocks can help you to not only weather the storm of a recession but also potentially take advantage of it.