Recessions can present uncertainty, and many investors wonder how they can strategically build a portfolio that can better withstand a recession when it inevitably occurs. Should you keep your assets in a savings account, stock market, real estate — or find other investment alternatives?
While all of these options have plenty of advantages and disadvantages at different economic stages, generally it’s wise to consider how your portfolio as a whole can withstand the economy taking a downturn. Though you can’t always completely sidestep a recession, choosing your investments wisely might help minimize the risk to your funds and provide a more steady cash flow. Deciding what to invest in during a recession based on historical economic trends might help bring you peace of mind with the investments you choose — even when there are, of course, no guarantees.
What Causes Recessions?
A recession is a term that describes a significant, prolonged, and widespread decline in economic activity that can last several months to years. Generally, experts declare a recession when the gross domestic product (GDP) experiences two consecutive quarters of decline, in addition to falling sales and rising levels of unemployment.
However, many other factors can cause a recession. Historically, some of the most common drivers of this economic state have included:
- Excessive debt: When consumers and businesses build up too much debt, they may get to a point where they can’t pay their bills. Substantial debt can lead to bankruptcies that capsize the economy.
- Inflation: Excessive inflation causes the prices of goods and services to rise and lead to higher interest rates, which can depress economic activity.
- Deflation: When prices and wages decline due to deflation, individuals and businesses stop spending, which further depresses the economy and can create a recession.
- Sudden economic shock: Any surprise circumstance could lead to financial damage. For example, a pandemic can shut down local and global economies.
- Technological change: While technology doesn’t necessarily create recessionary conditions, new inventions and technological advancements can sometimes cause disruption and revenue shifts in entire industries and contribute to recession conditions. Digitalization and labor automation can often reshape the nature of jobs in the economy, creating an unequal balance in labor market tightness and wage growth.
- Asset bubbles: When prices of an asset, such as real estate, bonds, stocks, or commodities, rise rapidly within a short period without the presence of underlying fundamentals to support the price increase, it can inflate the asset’s market — and lead to a crash when the demand and fervor subside. Asset bubbles are sometimes referred to as irrational exuberance.
When a recession hits, stock prices and other types of investments can experience a decline. During an economic downturn, markets can be volatile, and investors may see volatility in prices and market value. Additionally, investors might panic during this time and make quick decisions, potentially leading to more financial issues or loss in value.
Some investors may even pull their money out of the stock market entirely if they predict that stock prices will plummet. Large selloffs can drop a stock’s price, further damaging the value of others’ investments. This is what’s known as a negative feedback loop. In rapidly declining markets like a recession, fast selling leads to price declines, which precipitates more selling. Eventually, the value of the material, good, or asset is not as high as it could be.
7 Historically Defensive and Less Volatile Investments
Recession-proofing may not be possible, but positioning your portfolio with more defensive investments is an effective way to withstand economic downturns like recessions. Smart investors know that building a defensive portfolio starts with diversifying your investments.
Even then, it isn’t possible to time the markets to avoid any loss, so strategically choosing investments across different industries, with the help of a financial professional, could be one way to plan for the level of risk you’re willing to accept within your investments.
Historically, the following investments have not been as impacted by recessions, but that does not give any measure of certainty they will perform in a financial storm.
1. Pharmaceutical and Healthcare Stocks
Since demand for healthcare is relatively constant and generally less price sensitive than other industries, many healthcare and pharmaceutical stocks may outperform others during a recession due to their inelastic nature. During an economic crisis, people still need to be treated for illnesses and fill their medications. Healthcare is necessary, and many consumers will try to find a way to stay on their medication or seek treatment for a disease, even if it means cutting back on other purchases.
Stable demand for pharmaceutical services and technologies may act as a protective barrier for the healthcare industry during an economic downturn. Because drug stocks have historically been a positive investment in these downdrafts, many investors will flock to them, knowing they tend to weather well, which means these stocks may actually increase in value.
2. High-Yield Savings Accounts
Keeping your money in a savings account during a recession is another way to potentially mitigate the risk of losing funds in some stock market investments while keeping your money liquid. A typical savings account may not be the best long-term investment because you might not earn as much on your balance. However, putting your money in a high-yield account could be an effective way to ride out unstable economic times, as high-yield accounts successfully outperformed the stock market in 2018.
Like a typical savings account, a high-yield savings account still allows you to access your funds easily, so if you need emergency cash, your money will be right where you need it. However, you could lose purchasing power if your savings don’t grow enough to keep up with the rate of inflation. On the other hand, lower inflation rates are generally associated with lower interest rates, which can make it difficult to find a truly high-yield savings account at that time.
3. Large-Cap Technology Stocks
As with healthcare, many tech stocks have typically performed well during recessions because of the rapid growth of online consumers relying on digital products, such as smartphones, laptops, tablets, and TVs. Even if you begin to see unrealized losses on the tech stocks in your portfolio, you might consider keeping them. Many tech stocks, and even the sector as a whole, have seen consistent growth and dominated economic expansion throughout the pandemic, demonstrating that these stocks can weather the storm and come back up in value. Additionally, if you buy tech stocks during an economic downturn when prices are low, you may also gain more value as the economy returns to normal.
Investors may find more stability in large-cap stocks than small-cap stocks. Small-cap stocks come from public companies with a total market value generally below $2 billion, whereas large-cap stocks are shares from corporations with a market capitalization of over $10 billion. During uncertain markets, such as inflation and recessions, large-cap stocks tend to be less volatile and provide more quality and less risk than small-cap stocks. This is because many small-cap stocks tend to be from younger, less established startup companies, while large-cap stocks represent most of the U.S. equity market.
Experts say digital transformation is on the rise, and the demand for technology is not going away anytime soon. New products are being released quickly, which is why many investors might count on this type of investment for the long term. Some investors predict that economic slowdowns can even boost tech stocks due to past performance.
Generally, some large high-tech companies also pay dividends, which could help investors mitigate negative total returns, although this is rare for smaller tech companies.
4. Utility Stocks
Simply put, utilities are a necessity. History shows that utilities can maintain resilience in a slowing economy. Even when wages are low and prices are high, consumers still need electricity and running water in their homes for many essential activities. These are typical dividend-paying stocks.
Consumer demand and need for utilities continue even during a recession. For investors, these stocks can be a potential defense when the economy shrinks. Many utility stocks also tend to pay consistent dividends.
Utilities may even be more critical than healthcare for some consumers. They may hold off on paying medical bills or seeking new care and prioritize utility payments. With a decreased sensitivity to interest rates, many utility stocks can be a more steady flow of income for investors.
5. Precious Metals
Precious metals, such as silver and gold, have also been another defensive investment in downturns and uncertain times. While precious metals may not always outperform other types of investments in the long run, some investors see them as a safe haven during an economic downturn. Gold and silver will each have their own benefits and drawbacks, but they tend to have higher prices during recessions as investors turn to precious metals due to influence from market analysts.
Gold, for instance, doesn’t pay a dividend but is tangible. It also has a negative correlation to the equity market, which means it tends to appreciate during economic stress. Altogether, these factors may be more attractive to other investors when many other stocks aren’t as lucrative as they are in strong markets. Gold and silver are often in high demand during stock market unease because they are tangible assets that investors can physically hold onto and can help diversify one’s investment portfolio. However, owning physical assets means storing them somewhere.
Purchasing commodity-backed assets can be more convenient because investors don’t have to store physical assets. Exchange-traded funds (ETFs) tied to precious metals as their underlying asset class or stock in commodity-based companies can help investors create a large and diverse collection of securities without actually obtaining precious metals.
Whether investors purchase gold and silver outright or invest in commodity-backed ETFs and stocks, buying precious metals in any form can act as a hedge against inflation and add stability to a diverse portfolio.
6. Rental Properties
Housing investments aren’t necessarily a robust investment during recessions. During major economic depressions, housing prices tend to crash. On the other hand, rental properties can still be defensive during these times because they generally provide passive income, tax benefits, and more predictable returns, which can all mitigate risk against recession. Even during downturns, people still need housing. While home values can drop, rental cash flow rarely dips as much. Historically, the rental market has not been as impacted as the home prices during a recession.
Investors who choose an in-demand property in a good location and understand other potential risks involved with owning a rental property might mitigate devastating effects on the housing market. Landlords can adjust their rental rates to remain competitive and ensure they can retain tenants, which will bring in far more income than vacant units.
7. REITs and DSTs
Being a landlord isn’t for all investors, though. Other real estate investment options, such as non-traded real estate investment trusts (REITs) and Delaware Statutory Trusts (DSTs), could provide you with the real estate portfolio diversification that works for you.
REITs allow investors to pool their money and purchase real estate properties. By law, a REIT must pay at least 90% of its income to its shareholders, providing investors with a passive income option that can be helpful during recessions. Typically, the upfront costs of investing in a REIT are low, while their risk-adjusted returns tend to be high.
Because the healthcare industry is historically defensive during times of economic crisis, investing in a healthcare REIT can offer growth potential during a recession. As the pharmaceutical and healthcare industries are known to be historically defensive, they can be combined with real estate as assets in the REIT.
However, it’s important to remember that REITs also come with potential risks. The income investors earn from REIT dividends is taxed at the capital gain tax rate as portfolio income, not passive income. Because non-traded REITs are illiquid, selling them can also be difficult. This investment option also generally comes with various external fees.
With DSTs, investors can become part of a co-ownership system and contribute funding to buy properties and receive a share of the trust. This investment option makes it easier for investors to take fractional interest on larger properties that they may not be able to afford otherwise.
DSTs can provide investors with recurring monthly income, 1031 exchange eligibility, and asset appreciation, which can help protect investments during recessions and inflation. As with REITs, thought, DSTs also come with potential drawbacks. These include illiquidity, lack of early exit opportunities, additional fees, and lack of control when it comes to key operational decisions.
Partner With 1031 Crowdfunding
If you’re an investor, it can be enough of a challenge to navigate your personal finances during a recession, let alone your investment portfolio. At 1031 Crowdfunding, we aim to help you meet your investment objectives by guiding you through your options and supporting you in your real estate decisions. Our online marketplace of vetted 1031 exchange real estate offerings can help you identify the right properties to invest in if you want to diversify your portfolio.
With 1031 Crowdfunding, you’ll feel empowered with the knowledge and expertise to make informed decisions that can help you potentially earn more stable income during economic uncertainty. To learn more about how we can help you prepare for a recession, register for a member account today or visit our education center online for more information.
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