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How To Invest To Prepare For A Recession

The economy has that eerie “what’s coming next” feeling to it, and we’re all looking for ways to secure our money.

With inflation on the rise, and a recession possibly on the way, it’s important to have a game plan that can help you protect your money — and your mental health (aka reduce your stress!)

But when considering your investments during a recession, you first need to understand exactly what a recession is, and what its relationship to the stock market looks like. “A recession is two consecutive months of declining GDP,” says Alec Lucas, Ph.D., Director of Fixed Income Strategies and Manager of Research at Morningstar Research Services. “It’s a backwards looking metric. However, the stock market looks forward.”

That is to say a recession can only be confirmed after it occurs, which means — as you might have already guessed — you can’t time the markets. But thankfully there are some places you can invest that have historically been better during recessions and overall. Here’s what savvy investors need to look for.

Look at Business Models First

When looking at publicly traded companies that will continue earning even when times are tight, you’ll need to compare companies holistically to estimate how well they might be able to weather market downturns.

Here’s an example from Lucas: Take McDonalds (MCD) vs. Starbucks (SBUX). While Starbucks’ corporate office runs all of its storefronts and is responsible for its own inventory, McDonald’s, on the other hand, operates its business by selling licenses and renting property to franchise owners.

“Think of it this way. Let’s say I work for McDonald’s corporate,” Lucas says. “And you’re like, ‘Hey, I want to open up a McDonald’s. What’s it going to cost me?’ I tell you: ‘You pay me a fee and you get to be McDonald’s.’” You’d become a franchise owner who is responsible for the day-to-day health and wellness of your own McDonalds. On the other hand, with Starbucks, they own and operate all their locations, which means “their corporate office is in charge of buying the coffee beans, the cups, the plastic lids, everything. If they don’t sell all the bananas, for example, then the main corporation of Starbucks is on the hook for it. Whereas McDonald’s, they’re not. This is why the profit margins are often a lot higher for McDonalds than for Starbucks,” Lucas says. “You can look at a company’s financial report and find all this out.”

Lucas says he previously bought McDonald’s stock for his own children. “What’s made McDonald’s such a good investment is they own their real estate and they license their franchise. Their franchisees not only pay them to license the McDonald’s brand, they pay them rent, too.”

But the point here isn’t the difference between two companies’ business models — the point is that just because you may see a company’s logo on every major street corner does not mean that they’re created equal in terms of the shareholder value they’ll offer you, as an investor, over time. So, do your research. Make sure you’re happy with the fundamentals of a company’s business model before you invest.

Dividends Are Your Friends

Dividend growth funds, which are funds that hold stocks of publicly traded companies that pay regular cash dividends (generally every fiscal quarter), may be a solid option to look at right now. Funds including VIG or VDIGX are two Lucas suggests — but why dividend funds as opposed to growth stocks?

“So, a dividend growth strategy is looking for companies who aren’t necessarily yielding the most, but whose prospects should lead to increasing dividends, which typically comes along with increased share prices,” Lucas says. “Those, when you look at them at how they do in a downturn, they tend to do the best.”

Stay Diversified

While you may want to reallocate your portfolio during times of inflation, you don’t want to find yourself scrambling to diversify when a recession hits — which is one reason why it’s important to keep your portfolio diversified at all times. (No one wants to have to sell at a loss when the market corrects itself.)

“As a financial planner, we would not recommend adjusting your investment strategy based on predictions around economic conditions or particular industries,” says Jean Keener, CFP, CRPC Principal at Keener Financial Planning. “A better approach is to stay broadly diversified in US and international stocks and bonds. We recommend accomplishing this with low-cost index funds. There is academic research showing that small companies and value companies outperform over time, so women can also make sure their portfolios include a solid allocation to those companies (also through index funds).”

Take Inventory of Your Own Life

So far in 2022, 24,000 workers have been laid off from tech companies, and more layoffs are predicted. As the tech industry (and others) fluctuate, it’s a good time to audit your own career. If you’re early in your career and open to changes, it may be worthwhile to examine what jobs might offer security, no matter what market conditions are. If you’re working in an industry that may be prone to layoffs and you’ve been looking to make a career change anyway, now may be a good time to consider it.

“If women were going to make any adjustments in anticipation of the recession, I would encourage them to consider their career,” says Keener. Some industries such as healthcare (especially in the non-discretionary medical areas) and education are going to maintain their workforce regardless of economic conditions. In general, businesses that provide services for needs rather than wants are going to fare best during a recession.”

In short, recession-proofing starts with auditing your own life when you can. (And getting a side hustle in a more recession-proof industry counts, too!)

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