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3 Ways to Prepare Your Portfolio for a Recession

By Lawrence Rothman, CFA – Jul 23, 2020 at 8:54AM

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There are steps you can take with your investments in a downturn.

Unfortunately, the United States is officially in a recession. Tough economic times typically create angst, and when you add a pandemic into the mix, it is no wonder that many people are concerned about the future.

You can help alleviate some of the stress a recession inevitably creates by taking steps to shape your investment portfolio during these difficult times. After all, these challenging days will pass and you'll want your investments to work for you now and when growth returns.

Here are three things you can do to help make that happen.

A man leaps to avoid one low bar among a series of increasing bars.

Image source: Getty Images.

1. Examine your holdings

It is always a good idea to periodically check on your investments to see if you should buy more, hold onto your existing position, or sell. In a bull market, where business is good and many stocks are rising, it is easy to forge ahead and either invest more or maintain your portfolio.

Now is a good time to take a close look at your investments. For instance, if you are invested in cyclical stocks, you may wish to sell, since these companies' results suffer during a recession.

The important thing is to look at your entire portfolio with a fresh viewpoint. Once you have exited positions that you don't feel will do well in the current economic environment, you can move on to new investments.

2. Go on the defensive

After you have sold some securities, you can go on the prowl to look for attractive investment opportunities. Given the uncertain economic environment, you may wish to choose defensive companies that do well regardless of the economic state. Seeking out companies with strong balance sheets also adds a layer of protection since they don't have extra financial risk, a particularly important consideration during a down economic period.

Certain sectors, like consumer staples, typically weather recessions in good shape. Why? These are companies that sell everyday items, like food, which see fairly constant demand throughout the economic cycle. Some of these are familiar names like Procter & Gamble, which sells items including shampoo, toothbrushes, toothpaste, laundry detergent, and diapers; and Colgate-Palmolive, purveyor of toothbrushes, toothpaste, and soap, among other things. In other words, people will still buy these necessities even in a downturn.

This contrasts with other sectors, like consumer discretionary goods, that typically do poorly during a recession since people may have gotten laid off or are otherwise curbing their spending. In these times, consumers look to cut back on unnecessary expenses and hold off on major purchases like automobiles.

3. Seek out dividends

What other kinds of companies typically do well in a recession? You can seek out dividend-paying stocks. It is a positive sign when management has enough confidence in its company's prospects to continue paying dividends. While receiving regular dividends is always nice, it is particularly appealing when stocks are volatile.

Understandably, many companies have suspended dividends due to the uncertainty created by COVID-19. However, there are plenty of companies that have continued their payouts and even increased them. If you want to invest in companies that have regularly increased their dividends, there are Dividend Aristocrats, which are S&P 500 index companies that have raised dividends for at least 25 straight years. Companies like Procter & Gamble, Colgate-Palmolive, and Walmart (WMT -0.93%) are part of this esteemed group.

Certainly, there is no guarantee these companies won't cut their dividends, but the payment is obviously important to them.

No one likes to live through a recession, but it doesn't have to devastate your portfolio. In fact, you can do just fine by altering your approach from riskier companies to more conservative, defensive, dividend-paying ones with healthy balance sheets.

Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Walmart Stock Quote
Walmart
WMT
$131.68 (-0.93%) $-1.24
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
^GSPC
$3,744.52 (-1.02%) $-38.76
The Procter & Gamble Company Stock Quote
The Procter & Gamble Company
PG
$126.48 (-2.10%) $-2.72
Colgate-Palmolive Company Stock Quote
Colgate-Palmolive Company
CL
$69.56 (-2.18%) $-1.55

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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