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How Index ETFs Can Help Recession-Proof Your Retirement Savings

By Katie Brockman – Jul 21, 2020 at 9:06AM

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You can't eliminate risk entirely when investing, but index ETFs can help.

The country is currently in a recession, and nobody knows how long it will last. With the number of COVID-19 infections across the U.S. continuing to climb, the pandemic could affect the economy for quite a while.

That's troubling news for those preparing for retirement because recessions tend to go hand in hand with stock market downturns. If the market crashes, your retirement savings could tumble.

While there's no way to completely avoid the possibility of losing money on your investments during a recession, there's one type of investment that can significantly limit your risk while maximizing your gains: index ETFs.

Older couple sitting in the backyard.

Image source: Getty Images.

What are index ETFs?

Exchange-traded funds (ETFs) are large groupings of stocks and bonds. There are a wide variety of ETFs out there, with both niche and broad focuses. For example, you can invest in ETFs that focus solely on tech companies, pet care brands, or renewable energy businesses. On the broader end of the spectrum, then, are index ETFs.

Index ETFs track certain indexes, such as the Dow Jones Industrial Average or the S&P 500. You can't actually invest in an index itself, so an index ETF is the closest you can get. If you were to invest in an S&P 500 index ETF, for instance, you'd be investing in all the companies within the S&P 500.

Because indexes are generally good representations of the stock market as a whole, by investing in an index ETF, your investments will essentially follow the market. That might not necessarily sound like a positive thing during a recession when the stock market could take a turn for the worse. But the good news is that historically speaking, the stock market has always bounced back from every downturn it has ever experienced. So even if your index ETFs take a hit in the short term, there's a good chance they'll recover.

Who should invest in index ETFs?

Index ETFs are among the less risky investments to choose from not only because they're likely to bounce back after a market downturn, but also because they provide instant diversification. When you invest in a single index ETF, you're investing in dozens or even hundreds of different stocks at once. That can make them good choices for beginner investors, or for those who want to take a more hands-off approach to investing.

Some investors prefer to invest in individual stocks, and there's nothing wrong with that approach either. It is more research-intensive, however, because you'll need to assess each company to ensure you're investing in a stock that's likely to perform well over time. It's also a good idea to invest in at least 10 to 15 different stocks to diversify your portfolio. Diversification is especially important during a recession, when some companies may struggle.

For those who don't have the time or interest to choose individual stocks, index ETFs provide an easier option. Index ETFs allow you to instantly diversify your portfolio to limit your risk, and because they track indexes, your investments are more likely to recover if the stock market goes south. At the same time, though, they generally provide higher average rates of return than bonds and other conservative investments. In other words, index ETFs make it easier to minimize your risk while still saving as much as possible.

Saving for retirement during a recession can be tough, especially if another stock market downturn is on the way. Index ETFs, though, can make investing a little easier and help set you up for retirement success.

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