Investor sentiment can be influenced in a variety of ways, and when one is thinking about how to manage a portfolio during a recession, it’s important to recognize what information is truly important vs what is just noise. Media and other speculative forces can push sentiment in directions that don’t always follow the data.
So, what exactly is a recessionary market? The commonly-accepted definition of recession is when there are two consecutive quarters of negative GDP [1]. Those data sets aren’t officially released by the United States Bureau of Economic Analysis until two quarters after the fact, (for reference, Q3 of 2022 was negative but Q4 of 2022 was positive), so while we don’t know yet how the first half of 2023 will pan out, here are a few things to consider, in general, about recessionary markets.
Cash deposits are common “go-to’s” in a recession, but there are a few different approaches to holding cash with slightly different levels of risk associated with each. First, there are FDIC insured cash deposits. The FDIC protects depositors of insured banks located in the United States against the loss of their deposits if an insured bank fails. Any person or entity can have FDIC insurance coverage in an insured bank up to $250,000 per individual or entity. [2]
Secondly, there are higher yielding money market funds that provide a higher interest rate than basic FDIC insured deposits. Money market funds do not carry FDIC insurance and invest in very short term instruments in order to earn that higher yield. While they can have higher interest rates, there are a few considerations as well, including potential a higher risk relative to FDIC insured funds, minimum balance requirements, fees or withdrawal restrictions.
Alternatively, investors might consider bonds. Bond volatility is determined by both the quality of the issuer and the term, or length, of the bond. The longer time until maturity,, the higher the potential volatility of the bond as interest rates change. Finally, certain Exchange Traded Funds (ETFs) or mutual funds can help manage volatility as they create immediate diversification across dozens or even hundreds of companies. Common areas of conviction in the equity markets as times get volatile include high quality, dividend paying focused funds.
There are many details and considerations associated with all of the options above that should be taken into account and discussed with a financial advisor so that investors understand the complexities, nuances and risks of each investment option.
Most importantly, when an investor starts to feel pressure from third-party influencers, such as traditional or financial media, social media or just friends and family, it’s very important to check in with your financial planner to reground yourself with the goals of your plan and whether you can still be confident that in spite of recent volatility that all of your goals are still achievable with your current investment approach. Discuss whether you have the right diversified mix in your overall portfolio for the current or upcoming potential recessionary market.
In other words, don’t over react to the noise. Don’t try to “time the market”. Your long-term strategy should incorporate multiple layers of investments. Know what you own and why you own it to carry more confidence into any market.