Is It Safe to Invest During a Recession?
Whether the economy is in a state of expansion or contraction, investing always involves some level of risk. But smart investors know to embrace a long-term perspective, it’s important to look past the current state of the economy and establish a financial portfolio that reflects your investment objectives and your ability and willingness to assume risk.
During periods of recession (or in the time leading up to a recession), you can’t count on growth-oriented equities or high-yielding debt instruments to perform well. Instead, the best strategy for investing during a recession is to focus on lowering your level of risk on the margins of your investments. This can take various forms, but it usually involves some combination of the actions outlined below.
5 Investment Moves to Make During a Recession
- Increase your liquidity
- Establish positions in time-tested real assets, such as precious metals
- Increase your exposure to high-quality sources of investment income
- Reduce your exposure to volatile and highly leveraged financial securities
- Rotate away from small-cap stocks and mid-cap stocks in favor of more stable, large-cap stocks (particularly companies in defensive sectors)
Essentially, each of these moves is designed to reduce volatility and uncertainty, increase flexibility, enhance the reliability of cash flow, and limit your exposure to downside risk. You can learn more about these terms in our guide to investing for beginners.
Investments That Perform Well During Recessions
The investments that perform the best during a recession are high-quality assets that can maintain their value (or perhaps even grow) during an economic downturn. An asset that can generate consistent income is a bonus.
- Cash and Cash Equivalents
- A healthy cash reserve can increase your near-term flexibility and make it easier to invest in assets downstream (bargain buys). Unfortunately, during times of rapid inflation, holding too much cash can eat away at your purchasing power.
- Precious Metals
- Historically, precious metals like gold, silver, and platinum, have a high degree of resiliency during a recession. As a result, they are a nice way to diversify a traditional portfolio comprised of stocks, bonds and cash. Unfortunately, precious metals do not yield any income, which causes them to significantly underperform during periods of economic growth. Nevertheless, as part of a long-term investment strategy, they can significantly enhance the efficiency of your financial portfolio (return per unit of risk).
- Fixed Annuities
- To oversimplify a complex product, a fixed annuity is essentially a financial contract between an individual and an insurance company. In exchange for an upfront payment, annuities provide you with a guaranteed stream of income distributions. This investment isn’t right for everyone, but the embedded guarantee can be very valuable, especially during a recession.
- Investment Grade Bonds
- When it comes to financial securities, the best performing assets in a recession are generally high-quality debt instruments, such as U.S. Treasuries and investment-grade corporate bonds. These safe-haven investments tend to become more valuable (or, at least, maintain their value) during turbulent times. They also generate dependable streams of income, which is important during periods of uncertainty.
- Large-Cap, Defensive Stocks
- While stocks significantly underperform the assets noted above during a recession, you should never fully liquidate these holdings, regardless of the economic environment. When the economy is doing poorly, it can be sensible to shift your holdings away from small- and mid-cap stocks in favor of more stable, large-caps, particularly, those in defensive sectors, like utilities and consumer staples. These stocks show resiliency during economic downturns, and they kick-off dependable dividends.
Here are a few assets that do well during a recession:
Top 4 ETFs to Invest in During a Recession
An efficient way to defend your investments during a recession is to invest in exchange-traded funds (ETFs).
- SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
- Launched in 2007, this $19 billion ETF is focused on ultra-short-duration U.S. Treasury bills. Its holdings are high quality and minimally exposed to interest rate risk, making it a safe place to grow your liquidity reserve. It has an annual expense ratio of 0.14%.
- SPDR Gold MiniShares (GLDM)
- Launched in 2018, this $5 billion fund offers a hassle-free way to gain exposure to gold, the safest of the safe-haven assets. Each share of GLDM corresponds to a proportion of physical gold held in trust via a secure vault. GLDM has an annual expense ratio of 0.10%.
- Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)
- Launched in 2012, this $5 billion fund outperformed the S&P 500 by 14.6% in the first seven months of 2022. The fund has significant exposure to the utilities and consumer staples sectors. It has an annual expense ratio of 0.30%.
- Schwab U.S. Dividend Equity ETF (SCHD)
- Launched in 2011, this $39 billion ETF tracks the investment results of the Dow Jones U.S. Dividend 100 Index. Its constituents are among the largest, most well-established firms in the U.S. It has an annual expense ratio of 0.06%.
Investments That Perform Poorly During a Recession
Now that we’ve covered the asset classes that perform relatively well during a recession, let’s take a minute to highlight the ones that do not do so well.
The riskiest assets to hold during a recession are as follows:
- Highly speculative investments, such as cryptocurrencies and venture capital funds
- Growth-oriented small-cap and mid-cap stocks with low dividend yields
- Non-investment grade bonds (junk bonds) with very poor credit ratings
- Leveraged loans with weak collateral structures
These assets are highly sensitive to economic distress, and during tough times, they expose investors to significant price volatility and the potential for permanent loss of capital.
Other Frequently Asked Questions
A recession is an economic environment that is characterized by a sustained decline in economic activity, depressed consumer and business sentiment and a relatively high level of unemployment. Periods of high inflation can also be a telltale sign of a recession.
While there is no exact way to quantify the moment a recession occurs, economists often say a telltale sign is when there are two consecutive quarters of negative growth of gross domestic product (GDP)
If you notice this trend, you’ll want to take a look at your strategies for investing during high inflation.
Since the economy has experienced two consecutive quarters of negative GDP growth through June 30, 2022, many people claim we are already in a recession. This claim is also supported by flagging levels of consumer confidence and business investment.
However, one significant data point contradicts the recession claim: the unemployment level is currently very low (3.5% according to the latest report from the U.S. Bureau of Labor Statistics).
An investor should strive to maintain a long-term perspective that aligns with his or her time horizon. This entails maintaining a strategic asset allocation throughout multiple economic cycles. The allocation should be designed to optimize long-term performance, and it should not be subjected to knee-jerk reactions and drastic changes.
That said, modest tweaks that capitalize on the current economic environment can be sensible. During a recession, it usually makes sense to increase allocations to the following assets: cash and cash equivalents, precious metals, investment-grade bonds and large-cap, defensive stocks.
