Top 7 Tips to Protect Your Portfolio Against a Recession

Top 7 Tips to Protect Your Portfolio Against a Recession
Pic credit: Fortune

A profitable investment strategy starts with a profit-oriented game plan. What’s up, Guys. Welcome to The Comprehensive Minds. Regardless of how many years you have been investing, if you are reading this article, there is a good chance we agree that there is always more to learn. So, today I am sharing with you 7 things you can do to protect yourself against a potential recession.

Unless you are living in a cave somewhere, It’s not news that the U.S. economy is facing some serious challenges in 2022, and investors are concerned they might face a longer recession. A recession, of course, is a turning point in the business cycle where continued economic growth reaches its maximum, reverses, and continues to decrease.

The annual inflation accelerated to 8.6% in May, which caused the Federal Reserve to raise its benchmark lending rates by 75 basis points. Marking the biggest increase since 1994. The current high inflation levels, the loss of confidence in the economy, and rising interest rates can severely impact economic growth. In fact, the U S economy has actually shrunk in the first quarter of 2022 with a drop of 1.5% on an annualized basis.

Therefore, if you are still sitting on the sidelines. It is a good idea to have a game plan to protect your portfolio when you see these signs. Here are the 7 things you can do to protect yourself during a recession. Remember folks, this article is for educational purposes only. And, it should not be taken as financial advice. Let’s get unlocking.

1. Have enough cash reserves

The first, thing is to have enough Cash Reserves I understand. It is not attractive to hold cash during periods of high inflation. However, most people should hold a cash buffer, and make sure that they have sufficient emergency savings. It is recommended that people should have at least 3 to 6 months of expenses in a fully-funded emergency fund. As a good cash reserve can help investors in many different ways.

The first reason is that people need to make sure they have sufficient savings so they can be prepared for potential layoffs. I am not saying that history will repeat itself. But, after the 2008 financial crisis unemployment rates rose from 5% to 10%. And, in 2009 more than 15 million people were unemployed in the U.S. So, If a layoff occurs this time around, the extra savings will give you more time before you decide on your next career move.

Second, having enough emergency funds will alleviate the pressure to sell assets that you want to hold on to. And, retirees may avoid having to tap onto their retirement accounts or having to access a home equity line of credit during this period as well. Lastly, having enough cash to buy discounted assets can be a life-changing wealth-building event.

Why do you think Berkshire Hathaway was holding $144 billion of cash or cash equivalents at the end of 2021? Remember! The S&P500 was trading at the near 1500 levels in October 2007. And, it reached its lowest level of 735 in February 2009, roughly a year and 4 months later, after the financial collapse. But, if you were lucky enough to take advantage of the collapse, and bought assets near its lows, you would have gotten a 40% return on the first year alone!

If you haven’t sold or bought any assets, it took about five years for the S&P 500 to recoup all the losses it incurred since 2008. 5 years. And remember, the financial crisis of 2008, was maybe the worst financial crisis in global history, including the great depression of 1929. So, if you had cash, to start buying stocks after the 2008 financial crisis, you experienced the longest bull market in history.

From March 2009 to the stock market highs of 2022, the S&P, went up over 800%. Or, nearly 19% per year for 13 years. That’s an amazing opportunity, guys. Therefore, having enough cash to scoop up some great deals is a great idea.

2. Focus on Low-risk investments

Find quality companies with good cash flows and low debt for the safest investment options. Do you remember that advice from Peter Lynch? Companies that have no debt can’t go bankrupt. Recessions are not the time to experiment or take big financial risks. That is why the technology sector, and the crypto market, were the first markets to tank during the current bear market.

The crypto market alone has lost more than $2 trillion so far in 2022, as investors flee riskier assets. And the tech sector of the stock market has also seen some eye-popping drops. PayPal is down 63%. Align Technology is down 64%. Etsy is down 70%. And even investors’ darling Netflix is down 75%. Now, these are not some unknown companies with 2 employees, and a headquarter in some dark basement in the middle of nowhere.

Investors are clearly avoiding putting money into companies that are highly leveraged or have a speculative nature. So, maybe the most important investment strategy right now is to play it safe.

3. Focus investments in recession-resistant industries

Certain stocks are more vulnerable to negative macroeconomic shocks than others. Companies in the non-cyclical group are more resistant to market downturns. And, this happens because those companies produce everyday kinds of products and things that are needed regardless of disposable income and have a constant demand. In this group, you will find companies in the Consumer Staples, Utilities, and Healthcare sectors.

Those companies are steady earners, and often perform better than the cyclical stocks when economic activity is slow. You should also consider companies in the sensitive group. Companies in the sensitive group have only a moderate correlation with business cycles. And include companies in the communication services, energy, and information technology sectors. Remember. During uncertain times it is important to pick stocks that can both boost your portfolio income and also minimize risk when the economy is shrinking. If you want to learn more about cyclical and non-cyclical groups and stock sectors, you can check out this video we have on the screen.

4. Diversify

Diversification is critical when preparing for a possible economic recession. It is wise to avoid over-concentrating while investing. Even when that sector includes the previously mentioned consumer staples. If a specific company or industry gets crushed, being diversified will shield you from bigger losses. You should also consider diversification across asset classes such as bonds and commodities.

Commodities, especially precious metals, like gold and silver are known for retaining their value during periods of recession. Bonds also may perform well during recession times Because many investors flee the equity market looking for safer options. And, many opt for fixed-income guarantees such as U.S. Treasury bonds. Because the U.S government bonds are seen as the world’s safest in terms of the likelihood that the debt will be paid on time.

Now. Let me be clear. I am not telling anyone to go buy bonds. You should do your own research. But Right now, the initial interest rate on the new Series I savings bonds is 9.62%. And, you can buy up to $10,000 in I bonds at that rate through October 2022. They are a low-risk savings option and will at least protect investors from inflation.

5. Invest in real estate

A major recession can bring serious losses in most markets, including real estate markets. Poor economic conditions can lead to a decrease in the number of homebuyers with disposable income. Home prices drop when demand declines, and real estate income stagnates. However, this is merely a generalization. Since 1960 there have been 8 recessions. And, real home prices have declined an average of 5% during these recessions.

And, if you don’t consider the housing collapse of 2008, real home prices have declined an average of 0.61% during recessions since 1960. Not too bad when you compare that stocks lose 36% on average during a bear market. Additionally, a major recession can bring major opportunities. For instance, the average sale price of a home in the first quarter of 2007 was about $320,000.

After the great collapse, home prices averaged $257,000 when they hit their lowest levels in the first quarter of 2009. A nearly 20% decline in the average sales price. And, foreclosures more than doubled, from less than 150,000 to more than 350,000 during that same period. The combination of reduced pricing and more foreclosures creates huge opportunities for investors to scoop some cheap properties. You can sell it later when prices recover. Or you can rent it out to a tenant, and guarantee reliable passive income.

Video Credit: BiggerPockets

6. Invest in companies that pay dividends

Dividend stocks Buying companies that pay regular dividends to shareholders is one of my favorite strategies to protect myself against recessions. Dividend stocks also create passive income and it’s a great way to make your money work for you. This strategy provides investors with predictable income. Reduce risk, and allows shareholders to profit from owning the stocks without having to sell them.

In today’s unstable economic environment, dividend distributions provide investors, with some needed peace of mind. Look for companies that boast long-term expected earnings growth of at least 5% to 15%, have strong cash flows, and have low debt-to-equity ratios. Consider buying dividend aristocrats. The dividend aristocrats are a select group of the S&P500, who have been paying and increasing their dividend payouts for at least 25 consecutive years. Meaning. Every year you are likely to get a pay raise. Who doesn’t like pay raises?

7. Control your risk with stock options.

That’s right. Although, this one, I only recommend for more experienced investors. But. Yes. You can control your risk with stock options. Because a stock option gives investors the right to buy, or sell a stock, at an agreed-upon price and date. But not the obligation to do so. There are two types of options. You have Call options, which are bets that the stock price will rise. And, you have Put options, which are bets that the stock price will fall.

Now I understand why most investors consider stock options a much riskier investment. However, options contracts can actually be used to minimize risks. And, you can use stock options to hedge risk in many different ways. The buying and selling of calls, and puts, are the basis of options trading. You have to understand the two key principles, of exercising, and assignment in order to comprehend the risk involved in options trading.

When an option is exercised, the holder decides to sell, or, buy the underlying security, in accordance with the terms stated in the contract. What you really need to understand, is that when you purchase an option. The potential profit is limitless!!. While the total risk is restricted to the premium fee. However, when you sell options it could get very risky. Selling is risky. So, I wouldn’t recommend it to novice investors. Because the upside is limited by the premium paid. But, the downside or the amount of money you can lose is only limited by the movement in the price of the underlying stock. Making the trade much riskier.

Final Thoughts

There are some experts saying a recession is looming. But, we also have others experts who expect a stronger second quarter in 2022, pointing to solid personal consumption, despite surging prices. In the end, predictions are futile. No one can predict if and when a downturn will occur. But, investors should be proactive and take steps to manage risk and protect their investments from major declines.

Also Read:

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