After a decade of steady growth, the economic cycle is due for a reversal, with concerns of a recession.
Investors who have enjoyed rising asset prices are also getting antsy and fear an investment downturn. For anxious investors, now is a good time to review how to recession-proof your investments.
Recession is a term that describes the economy that experiences at least two consecutive quarters of declining economic activity as measured by the growth domestic product, GDP, and other economic indicators. A recession is declared after the fact by experts at the National Bureau of Economic Research.
Although recession talk is everywhere, Steven Jon Kaplan, CEO at True Contrarian Investments, believes that a recession is highly unlikely to occur before mid-2020.
Since 1960 an inverted yield curve has preceded a recession. Recently, the yield curve has inverted several times.
Normally, fixed income investments such as bonds, with longer maturities, have higher yields compared to those with shorter maturities.
"This results in a normal yield curve where yields slope up as maturity rates rise. When an inverted yield curve occurs, short term interest rates exceed long term rates," says Steve Chun, director of product and marketing development at Miller/Howard Investments.
The recent inverted yield curve might be a signal of an impending recession and reinforces the importance of creating a long term investment plan, instead of one that responds to short term market movements. But pinpointing a recession is a difficult feat.
Here are a couple things investors should keep in mind with a potential economic downturn:
-- Consider other types of investments outside of stocks and bonds.
-- Know that timing the market is difficult.
What to Invest in During a Recession?
To recession-proof a retirement portfolio, retirees should consider implementing an endowment spending model. If possible, instead of withdrawing a specific percent of one's investment portfolio, retirees can meet spending needs by living on dividends and allowing the principal to grow, Chen says. That way, when asset prices fall, the investor isn't selling the shares at a market bottom.
Recessions are typically preceded by inflation, Kaplan says. He suggests that as inflation rises, buying the U.S. dollar and U.S. Treasurys are a sound decision. Among the safest investments, these assets are popular and likely to rise during times of economic uncertainty.
Assets that are less correlated with typical stocks and bonds may be worth considering during times of uncertainty, says Chris Rawley, CEO of Harvest Returns. Harvest Returns is an online platform for agriculture based investments.
Several assets with low stock and bond correlations are gold and certain commodities such as timber.
Other less correlated assets include the real estate niche. With real estate crowdfunding, hypermarket segmentation is available. Investors can choose their property type and geographic region when investing in real estate. Two real estate crowdfunding platforms for accredited investors are CrowdFund and EquityMultiple. Fundrise and Groundfloor open targeted real estate investing to nonaccredited investors as well.
For easier real estate investing access, real estate investment trusts, known as REITs, come in many varieties and span several sectors.
The health care and senior living sector, for instance, might be more stable during turbulent economic times. Investors can tap the real estate health care and senior living markets with Physicians Realty Trust ( DOC) and Senior Housing Properties Trust ( SNH). A broad based, low fee REIT such as the Vanguard REIT ETF ( VNQ) diversifies across many sectors including health care, hotels, industrial, office, development, residential and specialized REITs.
For equity investors, recession-proof stocks are those more likely to hold up during market turmoil. Health, garbage and basic consumer products could fit the bill. Sample recession-proof stocks include Walmart ( WMT), Johnson & Johnson ( JNJ) and Waste Management ( WM).
It's wise for investors to remember that in the short and intermediate term, investing is volatile. That reality underscores the difficulty in removing the risk of investment losses.
Timing the Market Is Difficult
The only way to perfectly protect a portfolio from declines during a recession is to sell all investment assets and deploy those funds into short term U.S. Treasurys, bank certificates of deposit and cash. But that approach launches other risks. Investors will pay taxes on asset capital gains for investments owned outside of retirement accounts.
Predicting when the recession will occur is nearly impossible. When one is invested in cash, the investor misses any potential appreciation before the market drop. Plus, exiting financial markets creates the uncertainty of knowing when to get back into the markets after a decline.
That said, if an investor is more conservative, there's no harm in tilting the investment portfolio toward a greater allocation of cash type assets. That way, after a market decline there's an opportunity to bulk up on lower priced assets.
Ultimately, timing the market is a difficult task. That's why Daniel R. Hill, president and CEO of D.R. Hill Wealth Strategies, helps clients "clarify their short and long term goals, and then construct an asset allocation model that can complement their goals within a given time frame." That way his clients "have greater opportunities for a strong portfolio regardless of the economic climate," he adds.
Research has shown that timing the markets ultimately leads to lower returns than selecting a sound and diversified asset allocation and staying the course.
For most investors, understanding one's risk tolerance and time horizon and investing accordingly is the best way to handle a market decline. Retired investors and those planning on retiring soon should keep one to two years of cash available in case of a recession. That alleviates the potential of being forced to sell stocks and bonds during a market drop.
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