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“We all understand that markets go through cycles and recession is part of the cycle we may face,” said certified financial planner Elliot Herman, partner at PRW Wealth Management in Quincy, Massachusetts.
However, because no one can predict if and when a downturn will occur, he urges clients to be proactive with asset allocations.
Diversify your portfolio
Diversification is critical in preparing for a potential economic recession, said Anthony Watson, a CFP and founder and president of Thrive Retirement Specialists in Dearborn, Michigan.
You can eliminate company-specific risks by choosing funds over individual stocks because you’re less likely to feel like a company is failing within a publicly traded fund of 4,000 others, he said.
He suggests checking your mix of growth stocks, which are generally expected to provide above-average returns, and value stocks, which typically trade for less than the asset is worth.
“Value stocks tend to outperform growth stocks that go into recession,” explains Watson.
International exposure is also important, and many investors default to 100% domestic assets for equity allocations, he added. While the US Federal Reserve is aggressively fighting inflation, strategies by other central banks may set other growth paths in motion.
Allotments of bonds
Since market interest rates and bond prices tend to move in opposite directions, the Fed’s rate hikes have pushed the value of bonds down. The benchmark 10-year Treasury, which rises as bond prices fall, reached 3.1% on Thursday, its highest return since 2018.
But despite falling prices, bonds are still an important part of your portfolio, Watson said. If stocks plummet on the way to a recession, interest rates could also fall, allowing bond prices to recover, which could offset equity losses.
“Over time, that negative correlation tends to show itself,” he said. “It’s not necessarily day to day.”
Advisors also consider maturity, which measures a bond’s sensitivity to changes in interest rates based on its coupon, maturity, and yield paid over the lifetime. In general, the longer the maturity of a bond, the more likely it will be affected by rising interest rates.
“Higher yielding bonds with shorter maturities are now attractive and we have maintained our fixed income in this area,” added Herman from PRW Wealth Management.
Amid high inflation and low interest rates on savings accounts, it has become less attractive to hold cash. However, retirees still need a cash buffer to avoid the so-called “sequence of returns” risk.
You need to be careful when selling assets and withdrawing money as this can damage your portfolio in the long run. “That’s how you fall prey to the negative series of returns, which will eat your pension alive,” Watson said.
However, retirees can avoid tapping their nest during periods of deep loss with a significant cash buffer and access to a line of equity credit, he added.
The exact amount needed can, of course, depend on monthly expenses and other sources of income, such as Social Security or a pension.
From 1945 to 2009, the average recession lasted 11 months, according to the National Bureau of Economic Research, the official documenter of economic cycles. But there is no guarantee that a future downturn will not last.
Cash reserves are also important for investors in the “accumulation phase,” with a longer timeline before retirement, said Catherine Valega, a CFP and wealth consultant with Green Bee Advisory in Winchester, Massachusetts.
“People really need to make sure they have enough emergency savings,” she said, suggesting 12 to 24 months of savings to prepare for potential layoffs.
“I’m generally more conservative than many because I’ve seen three to six months of emergency costs, and I don’t think that’s enough.”
With additional savings, there’s more time to plan your next career move after a job loss, rather than being pressured to accept your first job offer to cover the bills.
“Having enough liquid emergency savings gives yourself more options,” she said.