How to Recession-Proof Your Stocks (and Financial Plan)
No doubt you’ve been hearing it a lot lately: “A recession is coming!” How do we know? Online search volume for the word “recession” is exploding, increasing by over 5x between July and August this year. Searches for “recession-proof stocks” quadrupled during this same time period. Clearly, the U.S. has recession 2020 on the brain, thanks in large part to the financial media’s flair for the dramatic.
In our own financial world, this recession fear manifests as a marked uptick in clients asking the questions, “Should I be investing during a recession? Is now the time to get more conservative with my investments?”
For those looking for a quick answer, the solution is unfortunately not straightforward or sexy; It’s sensible and a bit more complicated than just pulling funds out of the stock market. Below, I have outlined 5 rational steps to work through before making an investment decision that has ramifications well beyond any potential recession.
You’ll notice that none of these steps are based on what the stock market does; rather, they focus only on things we can actually control (Hint: we can’t control market fluctuation or predict when a recession will start or end, nor can we rely on “recession-proof stocks.”
Concept: Money needed in the short term should not be in the stock market.
STEP 1: Construct a financial plan to better understand your time horizon and estimated portfolio withdrawal rates. Identify your short-term financial goals and make sure the funds dedicated to paying for these goals are in stable, low-risk investments. Review your cash reserve targets and calculate how much is needed for an emergency fund.
Concept: Money that will not be needed for many years should be in the market (even during a recession).
STEP 2: Stress test your financial plan using Monte Carlo simulations to understand how different levels of risk impact your chances of success and goals. Determine the asset balances (exposure to equities vs. debt instruments) that will result in successful outcomes.
Concept: Know your own limits.
STEP 3: Review your personal risk tolerance (ability to stick to the plan during times of market volatility) relative to the portfolios that result in a successful plan. Blend your personal risk tolerance to the modeled outcomes and pick the asset balance that is right for you. This process will help you educate yourself as to how much of a drawdown you may see while investing during a recession. By understanding and acknowledging this in advance, you will be better prepared to stick to your plan.
Concept: Document your plan and have an accountability partner.
STEP 4: Determine what you will do if there is a recession, write it down, and tell someone that will hold you accountable. This can be as simple as saying, “I will maintain my systematic savings strategy (or better yet, save more!) and if my asset balance deviates by 5% (or whatever threshold you choose), I will rebalance. I will stay disciplined to my plan.”
Concept: Consider the recession impact on your income and expenses.
STEP 5: Review other risks a recession may bring. If you are employed, examine layoff risks and work to make yourself invaluable. If you operate a business, review how your income could be impacted and look for revenue streams that may not be impacted or consider ways to cut costs to maintain profits. Review personal cost-saving measures and debt reduction so you can maintain or increase savings during a bear market.
The bottom line is that a recession IS coming. We just don’t know when it will come, how severe it will be, or what the market will do prior to that recession. Many “experts” have been calling for this recession for the better part of a decade. As far as getting more conservative in your investments, my answer to that remains the same: Examine your own unique financial situation rather than trying to time the market or search for elusive recession-proof stocks
For a real-life breakdown of a hypothetical portfolio trying to time the 2008 recession, stay tuned for my next article: “It Was the Worst of Times.”