The stock market has been pretty volatile this past year with all the talk of another recession looming. It is important for most investors to create diversified and balanced portfolios in order to remain financially healthy through any upcoming economic crisis.
A diversified investment portfolio allows you to spread your financial risk. Should one sector of the economy take a downturn you are protected by having money placed in other sectors. It is important to regularly monitor your asset allocation so that you may determine where your greatest risks lie and then redistribute your investments to reduce your potential loss. Below we examine those instruments that a diversified and well-balanced portfolio should consider.
Large cap stocks within the consumer goods sector. During times of economic downturns, investors can focus on quality large cap stocks that offer you good dividend earnings. These stocks have proven, over time, to be resilient during market fluctuations. Their history has proven that the company has been able to withstand declining economic conditions.
When a recession does occur two things happen: companies make fewer business investments and consumers reduce their spending. Risk-adverse investors should stay clear of industries that are cyclical in nature, such as luxury goods, real estate, technology, travel and transportation, etc. Because each of these sectors undergo a drop in consumer spending, they are particularly susceptible to a recession.
Select the stocks of those companies with a history of continuous steady cash flow that enable the firm to weather any economic downturn. The consumer sector typically performs well during periods of recession. While these stocks may still dip in value, the slide is less precipitous than are the stocks of companies within cyclical industries. The best performing of the consumer-based stocks include food, beverage, healthcare and household goods, and cigarettes. The reason these stocks do so well even during recessions is that these purchases represent necessities rather than impulse or luxury buying. These are the products that are typically the last to be removed from most consumers’s shopping lists.
In addition to being recession-proof, most large cap consumer-based stocks also pay an attractive dividend. Such examples include the CocaCola Company, Proctor and Gamble, Merck, General Foods, Walmart, along with most major health insurance companies. Each firm has done fairly well even during the toughest economic cycles. Although mergers and acquisitions have affected the pharmaceutical industry in the late 20th and early 21st century, an index consisting of the largest pharmas would still have performed much better than more diversified indices.
- Fixed Income (FI) Investments and short-term bonds. During recessionary periods, many investors become risk-averse and sell their high-risk investments and move into safer securities such FI investments and government-backed short-term bonds. Although corporate-backed bonds and mortgage-based securities offer higher yields, they also have higher default rates than government-issued investments. Other short-terms FIs such as certificates of deposit and U.S. Treasury notes also provide a good measure of safety during recessionary periods.
- Cash is king! No doubt that cash is kind during economic downturns. When all other investments decline, cash retains its value. Although there is the risk of inflation which means you may mean you have to pay more for products and services, cash remains the safest vehicle for savings during a recession.
An added advantage to having cash is that when the recession lifts, you may use your cash savings to purchase attractive stocks when prices are low rather than using a margin account which will need to be paid back and eat into your profit. When economic times improve you may again redistribute your portfolio and introduce a bit more risk to the pie.
This was a guest post by Daniela Baker. She is a social media advocate at CreditDonkey, a credit card deals website. Daniela covers small business credit card deals and social media. She says, while very few investors survive a recession without at least some loss, you can reduce your risk by managing your portfolio wisely through the vehicle of diversification.