As odds rise for a recession, what's your investment strategy?
Odds for an economic recession in the U.S. seem to be rising by the day, so what should people do to prepare? Not much, financial advisers say.
That answer may surprise newer investors who’ve been fortunate to see mostly economic expansion and stellar stock returns in the past 25 years. But to those who have lived a bit longer and seen a few cycles, they know to just stay focused and patient.
“The message here is don’t do open heart surgery on your portfolio,” said Matt Fleming, senior financial adviser with Vanguard.
Will there be a recession in 2023?
With prices surging at the fastest pace in 40 years, the Federal Reserve has stepped in to rein it in by raising interest rates. The Fed increased its benchmark interest rate by 0.25% last month and is set to continue hiking rates to dampen demand for goods and services.
The theory is higher rates make borrowing more expensive, so people will borrow less. With less money chasing a limited number of goods, inflation will ease and the economy will gently slow.
But with inflation still accelerating, exacerbated by war in Ukraine and more COVID-19-related lockdowns in China, some economists fear the Fed has let the economy run too hot for too long.
“The Fed is behind the curve in a manner unseen in a generation,” Jim Reid, head of thematic research at Deutsche Bank, wrote in a note to clients. "Inflation is going to prove a lot stickier than expected, and hence monetary tightening will push the U.S. economy into a significant recession, with unemployment ultimately rising several percentage points.”
Deutsche Bank predicts a recession next year, while Goldman Sachs sees a 35% chance of one over the next two years.
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Don’t despair, look long-term
If you believe this gloomy backdrop, you may feel despair, especially with the stock market tumbling most days this year. The S&P 500 stock index has shed more than 12% year-to date, the Dow more than 8%, and Nasdaq-100 a whopping 20%.
But there’s no need to feel this way. Recessions tend to be shorter than expansions, according to the National Bureau of Economic Research, the official arbiter of business cycles. In the last 50 years, the longest recession lasted 18 months, compared with 128 months for the longest expansion, which was suddenly cut short by the pandemic in 2020.
Because of that, people who have time should take the long view and see market declines as a buying opportunity.
“Over the next few quarters and years, sell-offs are an opportunity in the markets that don’t come around often,” said Anthony Saglimbene, global market strategist at Ameriprise Financial. “If you can stomach the volatility and have 20 years to retirement, you can systematically buy stocks for your 401(k) and probably be more aggressive than a retiree who has no time for declines. You’ll be rewarded, especially if you’re dollar-cost averaging. That’s how to create wealth longer-term.”
Dollar-cost averaging, or regular buying at market prices, helps investors minimize the impact of volatility. Most financial advisers will tell you trying to time the market to buy low and sell high is often a fool’s errand, so they advise discipline, which means automatically investing at regular intervals to “smooth” out your purchase prices and remove emotion from your investment decisions.
“For many, it’s critical to remain disciplined and stay the course to meet long-term investment objectives,” Fleming said. But if you're older, “if necessary, based on risk tolerance, time horizon to retirement and investment objectives, assess whether portfolio refinements may be worthwhile given the shift in the economic landscape.”
What stocks do well in a recession?
The classic portfolio is the 60/40, which is 60% stocks and 40% bonds, to provide enough income growth from stocks and steady income from bonds. That allocation usually works for most people, especially if you're older and closer to retirement. If you’re young and brave, though, you could raise the stock portion relative to bonds based on how aggressive you want to be, Saglimbene said.
But “with risks of a recession elevated, we would advocate that now is not the time to abandon your appropriate allocation to bonds,” Fleming warned. “Investment-grade quality bonds have historically provided a nice ballast to stocks during recessions, and we would anticipate that to be a likely outcome in the future.”
On the stock side, Saglimbene says everyone should consider a high-quality value approach to mitigate risks. High-quality stocks are the tried and true, reliable, often large blue-chip companies that grow slowly but pay regular dividends like Johnson & Johnson, GE, IBM, and McDonald’s.
“Right now, the market is trying to figure out what the path is for growth and Fed policy,” Saglimbene said. “It’s very uncertain now, which is why we are seeing so much volatility. Once the Fed and the markets figure out the path, stocks will find a bottom and normalize, and investors will step back in.”
And those who stayed invested will reap the benefits, he said.
Medora Lee is a money, markets and personal finance reporter at USA Today TODAY. You can reach her at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.