Is a Recession Coming? How to Prepare Your Portfolio

With the forthcoming political change, some investors may be concerned that a recession is coming, too.

Why does that matter? When investors are spooked about the future prospects of the U.S. economy, they tend to turn away from riskier assets, such as stocks, and toward safer investments, such as U.S. Treasurys. (And when demand for Treasurys goes up, yields fall, as we saw with the recent declines in the 10-year Treasury yield.)

However, the economy has previously shaken off threats, including bank failures, interest rate increases and rising inflation. So while there are certainly indications of a recession on the horizon, it's not set in stone.

Regardless of how near or far away the next recession is, there are steps you can take now to prepare. Below are five things investors can consider to help get their portfolios ready for a potential recession.

1. Think before you rebalance

Rebalancing your portfolio — which involves buying and selling investments to restore your original asset allocation, or mix of stocks, bonds and other investments — is usually a good idea, but not during a market sell-off. When things are looking bleak, consider holding on to your investments. Selling during market lows can be one of the worst things you can do for your portfolio — it locks in losses. When the market evens out down the road, rebalancing may be in order.

When you do eventually rebalance, don’t discredit the emotions you had during recent stock market crashes. Knowing how you’ve reacted during past market fluctuations should be factored into how you allocate your investments going forward: If you pulled your money out of the market, or otherwise couldn't deal with the volatility, you may want to rebalance into a slightly more conservative portfolio so you can feel confident and weather future market drops with less stress.

If you’re not sure how your portfolio should be invested, consider opening an account with a robo-advisor, a digital investment management service that will help you determine your risk tolerance and then select and manage your investments for you.

2. Consider "buying the dip"

If you're in the kind of financially stable position that allows you to buy in a downturn, you could be setting yourself up for success down the line by doing so. Since timing the market perfectly is next to impossible, don't worry about trying to find the exact moment when stocks are at their lowest. Think about picking a few investments you've always wanted to own and give yourself a price threshold you feel comfortable with. If they drop to or below that threshold, you may get a bargain. Here's a primer on how to invest in stocks if you're new to this.

If you're already feeling financially strapped or may be facing unemployment, don't hedge your bets on a volatile market. Your money is better utilized in an emergency fund than on a risky investment. Only try to buy the dip if you can stand to lose that money.

» How to find cheap stocks

3. Remember why you chose your investments

Ideally, you chose them for diversification: Diversifying your investments can reduce your risk, just like spreading out your pieces in a game of Battleship — if they’re all in the same place, they’re more likely to get sunk.

Diversification doesn’t just mean allocating your money across different forms of investments like stocks or bonds. It also means that your money is spread across industries, geographic locations and companies of various sizes. This is always important, but careful diversification can especially protect you during a recession. When you're considering buying the dip, think about buying assets that increase your portfolio's diversification.

» Learn more: How to invest in a recession

4. Look at the necessities

Utilities are a classic lower-risk investment, but why? Utilities are essentials, and hopefully, most people will not have to forgo them during a recession. Household goods and other necessities are also considered recession-friendly investments.

It would be rash to move your entire portfolio in this direction, but adding a utilities or consumer staples index fund or exchange-traded fund can add stability to your portfolio even if the economy starts to feel uncertain. Here’s more on investing in index funds.

Note: You'll probably see lots of articles claiming a particular investment is recession-proof. It’s OK to listen to the buzz, but don’t buy into the noise without researching the company and industry.

» Learn more: Recession-proof stocks

5. Think about staying invested if you can

Try not to panic about the scary headlines and remember that staying invested is almost always the best response. Historically speaking, investors who hold on to their investments through recessions see their portfolios completely recover, and individuals who don’t invest in the market at all lose out.

Part of staying invested means protecting your portfolio from emergency expenses: Losing a job or having no emergency fund can force investors to dip into their investments. But most retirement accounts charge strong penalties — and often taxes — for early distributions.

The general aim is to have three to six months of living expenses saved in an online savings account, but if you can't get there right now, you're not alone in that struggle. Even a cash cushion of $500 helps.