The widespread consequences of Covid, supply chain disruptions, inflations, red-hot labour markets, and the Russian-Ukrainian war have driven many economies towards a potential recession. A recession is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. However, the political implications of a recession have seen a lot of economists and policymakers dilly-dally with the theoretical definitions of the word to save their blushes. But delay is not denial, as the IMF puts it, one-third of the world economy will likely contract this year or next amid shrinking real incomes and rising prices.
Amongst other efforts geared at avoiding a recession, global monetary authorities have tightened their monetary policies by increasing interest rates and reducing their holdings of certain securities.
The Nigerian economy is not different as the country is currently battling high inflation levels, devaluation of the naira, and the effect of other global factors previously mentioned, whilst struggling to keep the economy out of recession.
Bearing these in mind, investors must plan and structure their portfolios to minimize and possibly avert any losses that may arise from a recession. Some key tips to remember when investing in a recession include:
1. Choose your holding period (Short-term, medium-term, or long-term)
If your holding period is long, then you can buy undervalued non-defensive shares or equity mutual funds, which you would most likely not withdraw from in the short to medium term. For such shares, you would most likely not withdraw from them in at least five to ten years and thus, you shouldn’t worry about short-term market changes.
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However, if you need to access the funds soon e.g., in the short-medium term, purchasing bonds or holding cash (in a reasonably stable currency) will be ideal as you don’t want to be withdrawing money from your equity portfolio when the stock market is down. On the other hand, and as noted by Forbes Advisor, selling investments to get cash in anticipation of a recession is risky as you might sell prematurely and get trapped in cash as markets pick up.
Thus, a better strategy is to shift medium to long-term funds into investments that are well-positioned to weather a recession, whilst setting cash or highly liquid securities aside (e.g., money market mutual fund) for short to medium-term needs. This will help provide you with funds when needed, which helps you avoid dealing with market fluctuations.
2. If you must buy stocks for a short to medium-term holding period, buy defensive stocks
According to Investopedia, “a defensive stock is a stock that provides consistent dividends and stable earnings, regardless of the state of the overall stock market. There is a constant demand for their products, so defensive stocks tend to be more stable during the various phases of the business cycle.” Also, the Russian-Ukraine impasse has prompted countries to improve their defence budgets in case of an unpalatable world war.
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Utility, healthcare, and consumer staples stocks are examples of defensive stocks as they tend to be insulated from short-term economic fluctuations due to the essential nature of their products/ services, while consumer discretionary stocks tend to see strong gains when the economy is growing are cyclical in nature since gains and losses of these stocks depend on the rise and fall of economic cycles and consumer confidence.
Ownership of such utility, healthcare, and consumer staples can help protect your portfolio during a recession, as they typically outperform other stocks during a recession because regardless of the economic situation, these products/ services will be demanded.
3. Avoid growth stocks in a recession and consider dividend-paying stocks
Growth stocks, especially companies that are yet to make profits, are riskier and typically underperform other stocks during a recession. It is best to consider investing in stocks that are income-producing investments and dividend-paying as they can provide a cushion for your portfolio during recessions.
4. Consider investing in other alternative investments e.g., real estate, gold
Generally, home prices tend to increase during a recession, and owning a rental property can provide owners with a steady monthly income from tenants even in recessionary periods. However, across developed countries like the US and Canada, home prices are falling from the covid period’s all-time highs due to the increase in mortgage rates stemming from an increase in interest rates by monetary authorities. Thus, it may be wiser to hold off investments in real estate till the real estate prices decline back to almost normal.
Also, gold is seen as an investment haven as the price of gold often rises as stock markets plunge, and investors commence buying stocks again when the economy picks up and sells off their gold. Thus, gold is another asset that can be considered when investing in a recession.
5. Dollar-Cost Averaging Strategy
Dollar-cost averaging is an investing strategy where you buy a fixed amount of an investment (shares, bonds, mutual funds, retirement account, etc.) regularly, regardless of the current price. The strategy of dollar-cost averaging allows you to invest the same dollar amount consistently, whether the market is trending up or down. As a result, you would buy more shares of a stock when the stock price is lower and fewer shares when the price is higher.
Practically speaking, recessions are great opportunities to use a dollar-cost averaging approach because you can buy even more shares as the price declines. This can be carried out with new money or by simply setting your dividends to automatically reinvest in the stocks. As a result, dollar cost averaging can boost returns in the long run if the market rebounds.
On a final note, no one can know how long a recession will last or the extent of its damage to an economy. Thus, the best way to invest during a recession is to hold on to your current investment strategy. As noted by Forbes Advisors “While (recessions) can be challenging for returns and growing wealth, we also see countercyclical rallies and the market is always forward-looking, so the keys are to remain fully invested, not be whipsawed by short-term market gyrations and to keep (focused) on your long-term goals”.
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