Recession-Proof Your Portfolio

By Nancy Zambell, Contributing Editor

At the financial conferences that I have attended in the past few months, recession has been the primary topic. Traditionally, a recession is simply when the gross domestic product — the total market value of the final goods and services produced in the United States — goes negative for two quarters. In other words, when the economy is shrinking rather than growing.

At the conferences and in recent news, expert views have run the gamut: we're in a recession, we're closing in on one, or we are not going to have one. But what investors need to know is this: even if we are in a recession (if tradition holds) it will be over by the time the headlines pronounce it.

However, we must acknowledge that we are in an economic slowdown, whether or not you want to call it a recession. The price of gasoline has soared, unemployment rates continue to grow, the government and Wall Street are bailing out hedge funds and investment banks, the housing market is taking a beating nationwide, and the Federal Reserve is cutting interest rates like they are at a fire sale. In such situations, investors may need to make a few portfolio adjustments to maximize their returns.

Of course, as a long-term investor, I advocate that investors structure their portfolios to ride out short-term bumps in the economy and market. After all, history has shown us that the market's declines are eventually forgotten when the next bull surges and, given enough time, their investments are usually recouped, plus some.

Consequently, "quick fixes" are usually not the best way to create a long-term investing plan. Instead, investors should build their portfolios based on their personal goals and strategies. And there are some essential steps to take to make sure that you have a portfolio that can not only survive, but prosper during less-than-stellar markets.

Dollar-cost average, by investing a set amount of money regularly. That way, you will buy more shares when prices are down (such as in a recessionary period) and fewer in a rising price environment. But overall, your average price will be lower. Best of all, you will be regularly adding to your portfolio, rather than playing a loser's game of trying to time purchases and sales, which usually just results in buying and selling at exactly the wrong times.

Buy low-beta (low-risk stocks). Beta measures a stock's movement or volatility, relative to the market. A beta of 1 generally implies that the stock as a 1:1 correlation with the market. When the market moves up, (theoretically) so does the stock. A low beta (less than 1) would imply that the stock is not as volatile as the market, which would come in very handy in a declining market. Beta is easily found on most financial websites, including my favorite, www.finance.yahoo.com.

Diversify with different asset classes that don't have perfect correlation. This is the primary key for protecting your holdings. If you adequately diversify, you will have some cushion against the ups and downs of the market. Consequently, some of your assets should thrive in bull markets but others that are more defensive in nature should also be considered for the not-so-bullish times. These stocks perform below the market in bullish cycles but better during recessions.

These non-cyclical companies are high-quality, large-cap companies. They often pay a dividend and have stable, predictable earnings that are not dependent on booming economies. Some of the best examples are utilities. After all, even when the economy (and consumers) go through a rough patch, people still need water to drink and have homes to heat.

Additionally, consumer staples, businesses that manufacture food, beverages, household products and personal-care items, as well as "sin" stocks such as tobacco and alcohol beverage companies, also hold up very well during distressed periods. We still eat, drink, and clean our clothes and houses, no matter how bad the economy gets.

Health care, particularly managed care and medical device manufacturers, also tend to remain fairly insulated against economic trials, by generating a fairly predictable stream of earnings, revenues and dividends. With the aging of the 78 million baby boomers, these companies stand to reap some nice rewards during the next few decades.

Go international, but avoid emerging markets or export-driven markets whose fortunes depend largely on the United States. Instead, investors might want to add large-cap, proven companies in Western Europe, to their holdings.

Although in recessionary periods, most stocks underperform, traditionally, value stocks have outpaced growth stocks by about 4% during those times. According to a study done by Ibbotson Associates, the following are the returns of both classes of stocks during recessionary periods since 1969:

 If you make sure your portfolio is peppered with some stocks from each of these groups, you will still have room to add more volatile investments such as emerging markets, growth and technology stocks to your holdings. That way, you have the best of both worlds: stability and the potential for higher returns.

Certainly, it takes some time and effort to build a well-diversified portfolio, but investors do have other options besides buying individual shares. Fortunately, there are hundreds of mutual funds and exchange-traded funds (ETFs) that investors can purchase to help them structure all-weather portfolios.

The first step on the way to a well-balanced portfolio may be to buy a broad index fund or ETF such as the SPDRS (AMEX:SPY) that tracks the S&P 500. Then you can supplement it with any number of sector investments that will provide a more defensive position during a downturn.

Whichever avenue you choose to pursue, just make sure to buy fundamentally strong businesses with a healthy history of consistent revenues and earnings. That way, although their stock prices will most likely not see stellar growth during a recession, they won't roll over and die. You'll be providing good protection for your overall portfolio, and best of all, these defensive stocks should also net you some nice returns during the next bull run.

This concludes this week's issue of Financially Fit.  We encourage you to visit our website to review past issues of Financially Fit:

http://www.brokeradviser.com/newsletter.cfm


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