Worried about a recession? Here’s how to prepare a portfolio
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“We all understand that markets go through cycles, and a recession is part of the cycle we can face,” said certified financial planner Elliot Herman, partner at PRW Wealth Management in Quincy, Massachusetts.
However, since no one can predict if and when a recession will occur, he insists that clients actively allocate assets.
Diversify your portfolio
Diversification is critical in preparing for a possible economic recession, said Anthony Watson, CFP, founder and president of Thrive Retirement Specialists in Dearborn, Michigan.
You can eliminate company-specific risk by choosing funds rather than individual stocks, he says, because you’re less likely to feel like a company will fail in an exchange-traded fund of 4,000 others.
Value stocks tend to outperform growth stocks during a recession.
Anthony Watson
Founder and President of Thrive Retirement Specialists
He suggests testing a combination of growth stocks, which are expected to generate above-average returns, and value stocks, which typically trade for less than the asset is worth.
“Value stocks tend to outperform growth stocks in a recession,” Watson explained.
He added that an international presence is also important and many investors do not use 100% of domestic assets to place shares. While the US Federal Reserve is actively fighting inflation, the strategies of other central banks may lead to other growth trajectories.
Bond distribution
Since market interest rates and bond prices are usually are moving in opposite directions, the Fed’s rate hike has driven bond prices down. The benchmark 10-year Treasury bond, which rises when bond prices fall, reached 3.1% on Thursday, its highest yield since 2018.
But despite falling prices, bonds are still a key part of your portfolio, Watson said. If stocks drop sharply ahead of a recession, interest rates could also fall, allowing bond prices to recover, which could offset stock losses.
“Over time, this negative correlation tends to show up,” he said. “It’s not necessarily day-to-day.”
The advisors also consider duration, which measures a bond’s sensitivity to interest rate changes based on coupon, time to maturity, and yield paid over the term. Generally, the longer the duration of a bond, the more likely it is to be affected by rising interest rates.
“Higher yielding bonds with shorter maturities are now attractive and we have kept our fixed income in this area,” added Herman of PRW Wealth Management.
Cash reserves
With high inflation and low returns on savings accounts, holding cash has become less attractive. However, retirees still need a cash buffer to avoid the so-called “income sequence” risk.
You need to be careful when you sell assets and withdraw funds, as this can cause long-term harm to your portfolio. “This is how you fall prey to a negative income sequence that will eat your pension alive,” Watson said.
However, retirees can use their savings during periods of severe losses, with a substantial cash reserve and access to a home-secured line of credit, he added.
Of course, the exact amount needed may depend on monthly expenses and other sources of income such as Social Security or a pension.
From 1945 to 2009, the average recession lasted 11 months. National Bureau of Economic Research, the official documenter of economic cycles. But there is no guarantee that the future recession will not be longer.
Cash reserves are also important to investors in the “accumulation phase” as it takes longer to retire, says Katherine Valega, CFP and wealth advisor at Green Bee Advisory in Winchester, Massachusetts.
I tend to be more conservative than many because I’ve seen three to six months of emergency expenses and I don’t think that’s enough.
Ekaterina Valega
Welfare Advisor at Green Bee Advisory
“People really need to make sure they have enough savings for an emergency,” she said, suggesting 12 to 24 months of spending in savings to prepare for potential layoffs.
“I tend to be more conservative than a lot of people because I’ve seen three to six months of emergency expenses and I don’t think that’s enough.”
With extra savings, you’ll have more time to strategize your next career move after losing your job, instead of feeling pressured to accept your first job offer to cover the bills.
“If you have enough liquid savings for emergencies, you give yourself more options,” she said.
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