Danger, Will Robinson!
Are you ready for a recession, a downturn in the stock market and economy? It's not an immediate certainty, of course, but we'll surely encounter one again, and soon, according to some experts. None other than Alan Greenspan saw the risk of one as nearly 50% recently. He pointed to the subprime-lending mess we have on our hands, for one thing.
So let's say a recession is looming. What can you do to prepare for it? Well, a bunch of things. Some commentators are suggesting looking at exchange-traded funds (ETFs) that focus on stocks outside the U.S. and on defensive industries.
There are a variety of ETFs that invest globally. For instance, the Vanguard All World (VEU) ETF has half of its assets in Europe and another third in Asia. Of course, foreign companies and economies are still affected by ours, so you can't completely avoid the effects of a U.S. recession. But with more than 2,000 holdings, including Nokia (NYSE: NOK ) , Toyota Motors (NYSE: TM ) , and BP (NYSE: BP ) , you'll at least get plenty of diversification.
One area many people think of as a defensive industry is the consumer-staples sector. Many companies in the sector, such as Procter & Gamble (NYSE: PG ) , Altria (NYSE: MO ) , and Coca-Cola (NYSE: KO ) , are often thought to be as close to recession-proof as you can get. Still, don't expect miracles. Inflation and the rising cost of raw materials can put pressure on these companies' profits, too.
Looking for income
Another place to turn when you have recessions on your mind is to dividends. The iShares Dow Jones Select Dividend Index (DVY) ETF can help you out. It offers bits of more than 100 dividend payers, such as Merck (NYSE: MRK ) , for the price of one. Many of these companies tend to be in defensive industries, such as consumer staples, pharmaceuticals, and utilities, though some are also in the recently beleaguered financial sector (which actually has some attractive high dividend payers in it -- read Chuck Saletta for more). This ETF's yield is north of 3%.
Putting some bonds in your portfolio can add a healthy dose of diversification, too. Municipal bonds currently yield more than comparable Treasuries do, even though they pay tax-free income. But remember that in the long run, stocks have usually trounced bonds, so don't go nutty with them unless you're in or nearing retirement. And be especially careful of esoteric securities like emerging-market debt, because the risks can be extremely high.
Keep in mind
Of course, safety in a recession involves more than just having the right investment mix (and I wouldn't even argue with those who advise not changing your mix at all, but just sticking with your convictions and waiting out the recession). For example, you should also:
- Have an emergency fund, funded. Aim to keep between three and six months' worth of living expenses in short-term investments. These can be critical if you suddenly lose your job (hey, it happens, and more often in a recession) or encounter other unexpected big-ticket expenses (an operation or a new roof). Get more guidance in our Savings Center.
- Develop a healthy perspective on recessions. Welcome them, because they tend to bring bargains in the stock market. While others panic and sell, review your watch list regularly with a box of tissues nearby to help contain your drooling.
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