It has been more than six years since the end of the Great Recession, but it will not soon be forgotten. There were many lessons to be learned for investors, many of whom were swept away by a panicking herd only to see their retirement accounts devastated by 40 to 60% losses. In 2016, many know that, if they had simply held on, their accounts would have fully recovered and gone on to more than double in value. This is the first lesson of any recession. Any recession is followed by a recovery that includes a strong rebound in the stock market. The second lesson is that investors do not have to sit idly by as their portfolios get pummeled by massive selling. There are actually some investment strategies that can take advantage of recessionary forces to position your portfolio for a quicker and stronger rebound.
Dollar-Cost Average Your Way Down
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: what goes down always goes back up. 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 step up your game by increasing your contributions or starting dollar-cost-averaging in a nonqualified investment account.
When you dollar-cost-average your investing, you are gradually reducing your overall cost basis in the share price, so when the price rebounds, your cost basis is always 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 your 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.
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 do these companies do much better during economic downturns than companies carrying a lot of debt with poor cash flows, but they are also more likely to pay dividends. For investors, dividends serve a couple of purposes. First, if a company has a long history of paying and increasing dividends, you can have more peace of mind that it is financially sound and can weather any economic environment. 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 nondividend 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 generate high current yields with capital appreciation. But do not expect these funds to outperform the market during market rebounds. They are held in portfolios to provide stable returns across different market cycles. As the market rebounds, you can gradually allocate away from your dividend funds, but you should always maintain a portion as a defensive measure.
Invest in Consumer Staples
Even during recessions, consumers need to buy food, drugs, hygiene products and medical supplies. These are consumer staples that are the last items to be cut from the family budget. So while companies selling flat-screen TVs and other discretionary products likely experience drops in revenue, companies selling food products and personal necessities do not. The data shows these companies far outperformed the S&P500 during the last three recessionary periods. Consumer staple companies include Johnson & Johnson, Procter & Gamble, Coca-Cola and Wal-Mart. These particular companies also pay decent dividends, which strengthens their defensive postures. There are also mutual funds that invest strictly in consumer staples companies. 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. As of February 2016, the fund has returned 10.67% over the last 10 years.