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Forecasters increasingly say it may be time to prepare for the possibility of a recession.
A number of things are stoking that fear, but the Federal Reserve's moves to raise interest rates and rising inflation are currently the biggest factors. Those concerns — alongside an ongoing pandemic and continued supply chain issues — set off a volatile stock market, with the S&P 500 sliding into a bear market on May 20, 2022.
But there are steps you can take now to prepare in case a recession is, in fact, coming our way. Below, five things investors can do to help get their portfolios ready for a potential recession.
1. Don't rebalance just yet
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, do your best to hold 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. "Buy the dip" if you can
Thinking of market crashes as fire sales can help curb the panic. 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. Pick 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 reduces 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. Invest in 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. And regardless of how much research you do, resist the urge to try to beat the market.
» Learn more: Recession-proof stocks
5. Stay 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.
If you don't have any emergency savings, there are other strategies you can use to deal with a financial setback. And if you have to dip into a retirement account, know that a Roth IRA is typically the best last resort: it allows you to pull out contributions without taxes or penalties.
» Looking for recession advice beyond your investments? See our comprehensive guide on how to prepare for a recession.