What to Invest in During a Recession: 7 Dos and Don'ts

Introduction

Macro Trends

Given the rather grim macroeconomic outlook predicted by leading analysts and investors such as Jeremy Grantham, Michael Burry, and Ray Dalio, what should one invest in during a recession?

Recent years have been challenging for global markets. The global economy has been wounded by pandemic lockdowns over the past several years, leading to record-high inflation in many countries and causing stagflation in various regions.

Against this already somber backdrop, geopolitical complications such as the Russia-Ukraine conflict have increased the likelihood of recession. Technology stocks like Netflix have already lost more than 50% of their value, and the S&P 500 has retreated to its lowest levels in recent years.

While inflation erodes our cash savings on one hand, economic instability threatens financial markets on the other, leaving investors seemingly caught between a rock and a hard place.

However, if you know where to look, there are always opportunities to be seized. Here are some recommendations to help navigate these challenging times and identify potential investment opportunities during economic downturns.

What to Invest in During a Recession

Economic downturns can reveal some of the most profitable investment opportunities, as investors can purchase valuable stocks at discounted prices when all markets are in decline. This is precisely why successful investors view troubled economic periods as opportunities: they buy the dip.

Consider this: there has never been a recession or depression that hasn't passed. Economic shocks are a cyclical phenomenon. In other words, an investor can make money from their investments during downturns by strategically investing in companies with growth potential.

During recessions, certain investment strategies become particularly valuable. Understanding which assets tend to perform well during economic contractions can help investors not only preserve capital but potentially generate significant returns. The key is identifying sectors and instruments that demonstrate resilience or even benefit from economic uncertainty.

Here are some specific tips for investing during a recession:

1. Evaluate managed instruments such as mutual funds, index funds, and ETFs. These are asset portfolios that cover entire sectors, industries, markets, or indices. Therefore, they are generally a more balanced choice than investing in individual stocks. These diversified investment vehicles provide built-in risk management and professional oversight.

2. Consider keeping excess cash in safe, low-risk instruments like short-term fixed income funds. Because in a high-inflation and high-interest-rate environment like the second half of recent years, money markets will provide higher returns. This approach allows you to maintain liquidity while earning modest returns that can partially offset inflation.

3. Consider stock investments in recession-resistant sectors: these would be businesses providing essential goods and services such as basic food items, healthcare services, critical technology, energy and water supply, repairs, and even "pleasure sectors" including snacks and confectionery. These industries tend to maintain stable demand regardless of economic conditions, as consumers continue to purchase necessities even during financial hardship.

4. Consider discounted blue-chip stocks. If you don't mind taking some risk, stocks of fundamentally sound companies can be good investments during a recession. These established corporations often have strong balance sheets, proven business models, and the resources to weather economic storms, making them attractive long-term investments when purchased at reduced valuations.

5. Consider investing in gold, which has historically maintained its value even during periods of economic uncertainty. Gold serves as a traditional hedge against inflation and currency devaluation, providing portfolio stability when other assets experience volatility.

What Not to Invest in During an Economic Downturn

During a recession, avoid focusing too heavily on cyclical businesses such as tourism, hospitality, and entertainment. These sectors tend to be more vulnerable to economic downturns due to their dependence on consumer spending, which may decline during recessionary periods. When household budgets tighten, discretionary spending on travel, dining out, and entertainment typically decreases significantly.

However, it's interesting to consider the Lipstick Effect observed during the Great Depression in the 1930s. It describes consumers' tendency to continue purchasing small "extras" like cosmetics even during a poor economy. This phenomenon suggests that not all discretionary spending disappears during recessions, and some affordable luxury items may maintain demand.

Additionally, some manufacturing sectors tend to suffer due to declining demand or rising costs. Heavy industry and durable goods manufacturers often experience significant revenue declines as both consumer and business spending on big-ticket items decreases during economic contractions.

Avoid highly leveraged companies. These tend to be at greater risk of bankruptcy or insolvency because they have taken on large amounts of debt and will quickly be crushed under the repayment burden if their revenue streams dry up due to weakening economic conditions. Companies with excessive debt obligations face particular challenges when credit markets tighten and refinancing becomes difficult or expensive.

Crypto Investment During a Recession: Yes or No?

Conventional wisdom would say to stay far, far away from assets like cryptocurrencies, which are volatile even in a normal economy. The traditional investment advice typically emphasizes capital preservation during recessions, which seems incompatible with the high-risk nature of digital assets.

Over the past period, crypto has generally been moving in the red zone, with some exceptions. For example, Bitcoin has fallen by up to 72% from its historic peaks in late 2021. This dramatic decline illustrates the extreme volatility that characterizes cryptocurrency markets, particularly during periods of broader economic stress.

What's notable about crypto as an asset class is that it is very young. The cryptocurrency market has limited historical data spanning major economic cycles, making it difficult to predict how these assets will perform during prolonged recessions. Unlike traditional assets with decades or centuries of performance data, cryptocurrencies have only existed through a limited number of economic environments.

Therefore, whether during a recession or a normal economy, the same rules apply for crypto investment and indeed any investment:

• Invest only with excess cash or cash you can afford to lose. This fundamental principle becomes even more critical during economic uncertainty when job security and income stability may be compromised.

• Invest only if you have high conviction about crypto, as this will motivate you to do proper research. Understanding the technology, use cases, and long-term potential of cryptocurrencies is essential before committing capital, especially during volatile market conditions.

The decision to invest in cryptocurrencies during a recession ultimately depends on individual risk tolerance, investment timeline, and overall portfolio composition. For some investors, the potential for significant long-term gains may justify allocating a small portion of their portfolio to digital assets, while others may prefer to avoid this asset class entirely during economic uncertainty.

Is Cash King in a Recession?

Holding cash is quite important during recessions, considering that you could lose the money you've saved. Having sufficient cash will enable you to cover your expenses for at least a few months. This emergency fund provides crucial financial security and peace of mind during uncertain economic times.

From an investment perspective, cash can be a great asset to have during a recession. This is because it provides you with liquidity and can help you take advantage of investment opportunities that emerge as the economy recovers. When asset prices decline significantly, having cash reserves allows investors to purchase quality investments at attractive valuations.

However, depending on your financial goals, it may not be the best investment to make during a recession, especially if you have extra cash on hand. While cash provides safety and flexibility, it also faces challenges during inflationary periods when purchasing power erodes over time.

If your focus is long-term growth, it may be better to invest in other assets that have higher potential to appreciate over time. Balancing cash holdings with strategic investments in undervalued assets can position investors to benefit from eventual economic recovery while maintaining adequate liquidity for emergencies and opportunities.

Final Thoughts

There are a number of things investors can do during a recession to protect their portfolios and ensure they are positioned for success when the economy recovers. Successful recession investing requires careful planning, disciplined execution, and a long-term perspective that looks beyond immediate market turbulence.

• Diversify your investments. This means not putting all your eggs in one basket. Instead, spread your money across various asset classes and investments. Diversification reduces portfolio risk by ensuring that poor performance in one area can be offset by stability or gains in others. Consider including a mix of stocks, bonds, real estate, commodities, and potentially alternative investments to create a resilient portfolio.

• Be disciplined with your investments. This means staying true to your investment plan and not making impulsive decisions. Emotional reactions to market volatility often lead to poor investment outcomes, such as selling at market bottoms or chasing speculative investments. Maintaining discipline involves regular portfolio reviews, rebalancing when necessary, and avoiding the temptation to drastically alter your strategy based on short-term market movements.

• Remember that recessions don't last forever. While they are tough times for investors, they eventually come to an end. Historical data demonstrates that markets have consistently recovered from downturns, often reaching new highs within years of recession bottoms. Investors who maintain their composure and continue following sound investment principles during difficult periods are typically rewarded when economic conditions improve. The key is maintaining a long-term perspective and recognizing that temporary market declines often create the foundation for future growth and prosperity.

FAQ

What types of investments are relatively safe and hold value during economic recessions?

High-quality bonds, defensive stocks like utilities and consumer staples, and gold are relatively safe during recessions. A diversified portfolio helps protect against economic fluctuations and preserve wealth effectively.

What assets or industries should be avoided for investment during a recession?

Avoid cyclical industries like luxury goods, automotive, and entertainment. Skip high-leverage assets, speculative cryptocurrencies, and growth stocks. Steer clear of emerging markets with weak fundamentals and sectors dependent on consumer discretionary spending during economic downturns.

How to adjust your investment portfolio to reduce risk during economic recessions?

Diversify into uncorrelated assets like bonds and commodities. Increase allocations to defensive sectors such as utilities and consumer staples. Build cash reserves for flexibility and opportunistic buying during market downturns.

How do gold, bonds, and defensive stocks perform during a recession?

During recessions, high-quality bonds and defensive stocks like utilities and consumer staples typically outperform. Gold generally maintains value during economic downturns. A diversified portfolio helps manage risk effectively.

During an economic recession, should you hold cash or continue investing?

Balance both strategies. Hold cash for buying opportunities when assets are undervalued, while maintaining diversified crypto investments for long-term growth potential. Strategic allocation across both positions optimizes recession returns.

How to identify early signals of economic recession and adjust investment strategy in advance?

Monitor declining corporate earnings, consumer confidence, and trading volumes as early recession signals. Reduce high-risk assets, shift toward defensive sectors, and maintain cash reserves for opportunities. Diversify into stablecoins and low-volatility crypto assets for portfolio protection.

Which industries or company stocks are worth paying attention to and investing in during a recession?

Discount retailers and small indulgence stocks typically perform well during recessions. Consumers become more price-sensitive, benefiting these sectors. Healthcare, utilities, and consumer staples also show resilience during economic downturns due to stable demand.

How should beginners start investing during a recession?

Start by building an emergency fund, then invest in stable assets like Bitcoin and Ethereum. Dollar-cost averaging helps reduce timing risk. Research fundamentals, diversify your portfolio, and focus on long-term gains. Begin with small amounts you can afford to lose.