Lately, it may appear like the sky is falling in on investors. However, if you explore beyond the realm of traditional investment, you’ll discover that some asset classes are doing rather well in the middle of recent market disasters.
The topic of how to handle your investments during a downturn is ageless. But, the answers have varied considerably throughout time. Previously, altering your asset allocation away from stocks meant shifting into bonds, gold, or cash; however, the range of alternative investing possibilities has risen enormously in recent years.
We understand how liquid assets such as stocks, bonds, and credit fare amid an economic recession or market upheaval. But what about alternatives, an asset class in which investors have invested trillions of dollars over the last decade? How will they fare in the event of a downturn? How recession-resistant are they, and how much downside return protection can they provide?
These are critical questions to attempt to answer. Not only because alternative investments have grown in importance in portfolios over the last decade. But it’s also because bond rates are at an all-time low. Many bonds, such as government bonds, mortgage, and municipal bonds, and A-rated corporate bonds, have historically given strong downside return protection to investors.
Investors may now diversify their portfolios more than ever before, but knowing how these alternative assets perform during economic turmoil is critical to realizing the full diversification benefits they provide.
During a recession, assets such as equities can fall as individuals stop spending, jobs are lost, and corporations reduce their investments. However, there may be bright spots—or at least less ugly ones—in the market that can withstand a downturn. We’ll discuss what a recession is and which investments perform best in bad times.
What exactly is a recession?
A recession is a long-term economic slowdown that lasts longer than a few months. Two consecutive quarters of decreasing GDP characterize a recession. However, a recession happens when”a major fall in economic activity distributed across the economy, lasting more than a few months,” combined with other signs, per the National Bureau of Economic Research (NBER).
Many experts have predicted that the United States will suffer a recession by 2023. Some believe we are now in one.
During a recession, investments frequently lose value, and investors’ investment portfolios suffer.
As the economy slows, firms have fewer reasons to produce and deliver services, resulting in layoffs or hiring freezes. People who are out of jobs tend to cut back on their spending, further weakening the economy, and there you have your recession.
One of the most widely recognized approaches used by experts to determine a recession is to examine the country’s GDP or the value of goods and services generated in a country. When the GDP exhibits negative growth for two consecutive quarters, it indicates a recession.
Finally, it’s difficult to forecast when a recession will occur. In any scenario, it might be beneficial to ensure that your funds are in order in case something unfortunate occurs.
Alternative Investments: The New Recession-Proof Investments
The economy is not recession-resistant. The economic cycle is a relatively predictable albeit irregular pattern that it frequently follows. Periods of growth might extend for years before reaching a climax. What follows is a period of contraction, or a recession, before the economy enters a trough in preparation for the next upswing.
Investors might suffer greatly during recessionary periods. During the contraction period, stock market declines and bear markets are prevalent. During a recession, cyclical equities (businesses in industries that are particularly susceptible to the economic cycle) are frequently the most impacted.
Some assets, on the other hand, are generally susceptible to the peaks and valleys of the economic cycle. They provide investors with fairly recession-proof investments that they may hold in the event of economic upheaval. Here’s a closer look at alternative investments and where to put your money if you’re concerned about the economy.
Alternative investments, or simply “alternatives,” are any non-traditional investment strategies. Alternative investments include non-traditional asset classes such as private equity, hedge funds, real estate, and commodities, which serve as “alternatives” to fixed-income and equity instruments. Alternative investments were once thought to be an “elite” asset class, reserved primarily for hedge funds and other high-earning investors.
For the previous decade and a half, the alternative investments business has increased in popularity and accessibility, owing partly to the global economic slump in 2008.
When the stock market plummeted, many people who had previously depended largely on traditional investments saw the value of their investments fall, prompting many to explore alternative investments. Alternatives have a poor correlation with traditional assets, which means they tend to trend in opposing directions. As a result, they are prudent additions to the portfolios of investors seeking to diversify, disperse risk, and boost profits.
The Best Alternative Investment Assets To Invest In During A Recession?
During a recession, the stock market suffers, but not all industries and assets suffer equally. During a recession, certain assets are more robust than others.
- Real Estate: Real estate is a well-known asset that generates wealth for generations, protects against inflation, and is recession-resistant. During a recession, commercial real estate investments can be more resilient than other investments; nevertheless, not all asset classes of real estate investments will be able to endure the storm. The properties most likely to do well in a downturn will have four characteristics: a good location, excellent fundamentals and functionality, enough cash flow, and minimal capital needs. Housing is not a recession-proof investment. Indeed, during economic downturns, house values tend to fall. However, because of the passive income they produce, rental houses may still be defensive in economic downturns. Indeed, chances for landlords may improve if potential purchasers decide to rent instead until the crisis ends and people still need homes to live in. The same cautions apply whether you are buying in a recession or not, such as selecting an in-demand home in a well-located neighborhood and recognizing the effort and hazards associated with owning a rental property.
- Cash: When it comes to recessions, cash is a valuable asset. After all, if you do find yourself in a circumstance where you need to use your assets, having a separate emergency fund to fall back on is beneficial. Especially if you get laid off. In general, an emergency fund should cover three to six months of living expenditures. Think about rent, utilities, food, meds, minimum debt payments, etc. If you need to tap into your fund, you may do so while allowing your other investments to weather out market lows and gain long-term growth. These monies should ideally be kept in a high-yield savings account.
- Large-capitalization stocks: Large, well-run corporations with high valuations are the asset types that tend to do best during recessions. Companies that manufacture things that people buy regardless of the economy—think diapers and utilities—do well because people keep buying them. Food, personal care items, healthcare, and utilities are examples of these categories of stocks. Whether the economy is robust or weak, people need to eat, clean their teeth, go to the doctor, and heat their houses. That is not to say that people will not modify their spending habits within a sector. In a poorer economy, for example, people may go from steak to hamburger, or from Nordstroms to Walmart. Large-cap and more established company stocks are an appealing alternative. One reason investors like these stocks is that they pay dividends, which are payouts made to shareholders as a means for firms to pass along part of their profits. As a consequence, even if their prices do not rise, they will provide investors with the potential to make a return on their investment.
- Gold: Historically, the value of gold has risen during times of economic downturn. For example, from 1976 to 1978, the S&P 500 plummeted 19%, while gold climbed 54%. The S&P 500 fell 19% in 2011, while gold climbed 9.4%. This pattern isn’t universal (gold did fall during the recessions of the early 1980s and late 1990s), but it holds in general. As a result, gold might be a wise investment during these difficult economic times. In recessions, when paper assets such as equities and bonds are devalued, firms and employees feel the strain and tend to flee to the safety of gold, explaining its recent climb. Gold is a wager against the US currency. Moreover, during recessions, when trust in the Federal Reserve is low, individuals tend to place their trust in non-fiat currencies that are not supported by what they perceive to be failed central bankers and governments.
But, What Alternative Investment Assets Should You Avoid Holding During A Recession?
A recession can affect your overall investment portfolio, but certain assets perform poorly during a recession.
- Cyclical firm stocks: Firms that vary with the economy are on the other side of the stock market. These are companies whose profits are highly associated with the wider economy and which do well when the economy is booming. As a result, when the economy suffers, these stocks tend to follow suit. These businesses operate in the following industries: manufacturing, construction, leisure, and travel. Companies that manufacture discretionary goods or services suffer during a recession since they are often the first items customers cut down.
- Cryptocurrencies: Cryptocurrencies are digital currencies, an alternate form of payment produced via encryption technology. Cryptocurrencies act as both cash and virtual accounting systems. Bitcoin and Etherium are two examples. Cryptocurrencies are unregulated, uninsured, and tough to convert into actual money. They may be exceedingly volatile, as seen by the recent plunge in the value of cryptos to two-year lows. Cryptocurrencies are the most speculative asset class today. The emergence of cryptocurrencies during the Coronavirus pandemic was spurred by the Federal Reserve injecting unprecedented quantities of liquidity into financial markets. As a result, highly speculative cryptocurrencies such as Bitcoin and Ethereum are among the worst asset classes to own during a recession.
If you believe a recession is near, it may be appealing to change your investment plan or perhaps exit the stock market entirely. However, doing so might result in huge losses. As a result, it’s critical to keep a long-term view.
All market losses are just transitory since the market has always gone on to greater highs in its almost 200-year existence. Instead of being afraid to participate in a weak or sinking market because of recessions, investors should regard reduced prices as chances to purchase assets at rates they may never witness again.
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During a recession, a useful investing approach is to search for firms retaining strong balance sheets or stable business models despite economic headwinds. Utilities, basic consumer products conglomerates, and defense stocks are examples of these corporations.
Yes, you should invest during a recession. During a recession, however, you may want to limit investments in firms or industries that are cyclical, speculative, or high-risk. Instead, search for stable firms with minimal debt, positive cash flow, and proven markets for their products and services.