Personal Finance
How investors can ready their portfolios for a recession
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The odds of a U.S. recession have risen amid an escalating trade war. But most investors should ignore the impulse to flee for safety by exiting the market, financial experts say.
Instead, the best way to brace for an economic shock is by double-checking fundamentals like asset allocation and diversification, they said.
“You’re looking for balance rather than casting your lot with any one economic outcome,” said Christine Benz, director of personal finance and retirement planning for Morningstar.
The probability of an economic downturn rose to 36% in March from 23% in January, according to fund managers, strategists and analysts polled for a recent CNBC Fed Survey. A recent Deutsche Bank survey pegged the odds at almost 50-50.
President Donald Trump hasn’t ruled out the possibility of a U.S. recession and earlier this month said the economy was in a “period of transition.”
Recession isn’t assured, though, and economists generally agree the chances are relatively low.
‘Market timing is a bad idea’
Trying to predict when and if a recession will happen is nearly impossible — and acting on such fear often leads to bad financial decisions, advisors said.
“Market timing is a bad idea,” said Charlie Fitzgerald III, a certified financial planner based in Orlando, and a founding member of Moisand Fitzgerald Tamayo. Trying to predict market movements and exit before a decline is like “gambling, it’s flipping coins,” he said.
When it comes to investing, your strategy should be like watching paint dry, he said: “It should be boring.”
He often tells investors to focus on ensuring their portfolio is properly diversified instead of worrying about a recession.
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When the economy heads toward a recession, it’s natural for investors to worry about falling stock prices and the impact on their portfolio. But investors quite often make bad moves and guess poorly, experts say.
Emotional behavior — selling stocks during market downturns and missing the rebounds — is a big reason investors underperform the broad market, experts said.
The average stock investor earned 5.5 percentage points less than the S&P 500 in 2023, for example, according to DALBAR, which conducts an annual investor behavior study. Investors earned about 21% while the S&P 500 returned about 26%, DALBAR said.
The story was similar in 2022: Investors lost 21% while the S&P 500 declined 18%, it found.
Stocks have always recovered after bottoming out during recessions, Fitzgerald said. Missing those rebounds can be costly, he said.
“I’d definitely urge people to tap on the brakes before making big shifts in anticipation of some market outcome,” Benz said.
Check your asset allocation
That said, the prospect of a recession is a good time for investors to revisit their portfolios and make small adjustments, if necessary, experts said.
Advisors suggest investors examine their asset allocation to make sure it’s appropriate for their goals and timeline, and to rebalance if their allocations have gotten out of whack. They should be diversified among (and within) asset classes, experts said.
A target-date fund or balanced fund held in a retirement account may be good options for investors who want to outsource asset allocation, diversification and rebalancing to a professional asset manager, Benz said.
Young investors saving for retirement — and who are more than 20 years from reaching their investment timeline — should generally be 100% in stocks, Fitzgerald said.
However, there is one exception: Investors who are also saving for a short-term need within three to five years, perhaps a down payment on a home, should not keep those funds in the stock market, Fitzgerald said. Put that money in a safer place like a money market fund, so you know it’ll be there when you need it, he said.
Retirees and near-retirees may benefit from a less risky portfolio, experts said. An allocation of 60% stocks and 40% bonds and cash, or a 50/50 split are good starting points, Benz said.
Retirees generally need to keep a chunk of their portfolio in stocks — the growth engine of a portfolio — to help their investments last through old age, advisors said. Bonds generally act as a ballast during recessions, typically rising when stocks are falling, they said.
Retirees who rely on their investments for income should avoid withdrawing from stocks if they’re declining during a recession, advisors said. Doing so, especially within the first five or so years of retirement, raises the odds that a retiree will deplete their portfolio and outlive their savings, research shows. (This is called “sequence of returns” risk.)
Retirees who don’t have a bucket of bonds and cash from which to pull during such times may benefit from preparing while the economy is still strong, Benz said.
“If you have a portfolio constructed well enough, [a recession] will be uncomfortable and the waves will toss [the ship] around a little bit, but the ship isn’t going to sink,” Fitzgerald said.
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