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Investing during a recession

Key takeaways

  • Recessions are not the time to abandon your investment strategy.
  • Bonds and cash have historically outperformed most stocks during recessions.
  • Selling stocks in favor of bonds and cash before a recession may leave you unprepared if stocks bounce back before the economy does, which has happened historically during many recessions.
  • Recessions typically last less than a year before giving way to the early cycle when markets have historically delivered some of their biggest gains.

Recessions are times when economic activity contracts, corporate profits decline, unemployment rises, and credit for businesses and consumers becomes scarce. During the 11 recessions the US has endured since 1950, stocks have historically fallen an average 15% a year.

This history may suggest that selling stocks before a recession arrives and buying them after it departs would be a smart strategy. But savvy investors know that it is extremely difficult to do this successfully and often a recipe for locking in losses instead. Rather, the approach of a recession is a good time to set realistic expectations for what may lie ahead, review your portfolio, and carefully make any moves that may be necessary to make sure it remains aligned with your long-term goals. While recessions can't be avoided, there are things you can do—and things you shouldn't do—to reduce their impact on your finances.

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Like a hurricane

The first thing to do as a recession approaches is to resist anxiety and fear. People fear recessions because of the layoffs and volatile markets that accompany them, but fear is neither a good basis for making investment decisions, nor a reason to be unprepared when a recession arrives. Much like tropical depressions that gradually strengthen into powerful storms, signs of an approaching recession can be seen well in advance of its arrival and investors and consumers can take steps to get ready.

While recessions don't last long—only 9 months on average—they can pummel portfolios that have too much exposure to some types of assets and not enough to others. Over the long run, stocks have historically delivered the highest returns of any asset class, but they have also historically been the worst performers during recessions, trailing both bonds and cash. With history as a guide, here's what you might expect from your portfolio when an eventual recession arrives.

Investment returns before, during, and after recessions

This chart shows how stocks, bonds, and cash have historically performed at various times in the business cycle.
Past performance is no guarantee of future results. Asset class total returns represented by indexes from the following sources: Fidelity Investments, Ibbotson Associates, and Bloomberg Barclays as of March 31, 2021. Source: Fidelity Investments proprietary analysis of historical asset class performance, which is not indicative of future performance.

Bonds in recessions

In every recession since 1950, bonds have delivered higher returns than stocks and cash. That's partly because the Federal Reserve and other central banks have often cut interest rates in hopes of stimulating economic activity during a recession. Rate cuts typically cause bond yields to fall and bond prices to rise.

For investors in or nearing retirement who want to reduce their exposure to stock market volatility, the period before a recession may be a good time to consider shifting some money from stocks to bonds. That's because the Fed is typically raising interest rates to slow growth, which means lower bond prices and higher yields.

Keep in mind, though, that the bond universe is a far more vast and variegated place than the stock market and not all bonds perform equally well during recessions. Investment-grade corporate bonds and government bonds such as US Treasurys have historically delivered higher returns during recessions than high-yield corporate bonds. Moore expects that prices of high-quality corporate bonds will recover strongly once the economy and inflation slow, and Fed begins cutting rates to stimulate growth.

Cash in recessions

While maintaining a large allocation to cash is not a good long-term strategy for most investors, cash held in certificates of deposit (CDs) and money market funds has historically provided a cushion against market downturns during recessions. In the late phase of the economic cycle which precedes a downturn, interest rates typically reach their highest levels. For investors who want to earn income while preserving capital it may be a good time to consider purchasing longer-term CDs which can provide income through a recession and beyond.

Money market funds are another option for holding on to cash during a recession. While their yields may eventually fall when interest rates do, they can offer protection for your capital and easy access to your cash when longer-term investment opportunities reappear.

Stocks in recessions

Overall, stocks have usually struggled during recessions. Stocks of companies in industries such as technology and media which consumers and businesses can postpone spending money on have been among the worst performers during recessions. Financial stocks have also historically found the going difficult.

Not all stocks have weathered recessions badly, however. Stocks of companies that make and sell goods and services such as food, healthcare, and electricity that people need to purchase regardless of the state of their personal finances or the phase of the business cycle have performed relatively well compared to other categories of stocks during recessions.

Surprisingly, perhaps, consumer discretionary stocks—travel, clothing, housewares, and other non-essential products have also fared better during recessions than they have in the period immediately preceding a downturn when they have often sold off in anticipation of bad times ahead.

Stocks of companies that obtain much of their revenues from outside the US may also be worth considering in the period prior to a recession. While the US has yet to enter recession, other parts of the world such as the EU have likely already been in recession and will likely recover before the US. Typically, markets recover from a recession well in advance of the return of economic growth so international stocks may offer recession-wary US investors the opportunity to potentially diversify away some risk.

Some types of stocks have historically performed better than others in recessions

This table shows how various stock market sectors have historically performed at various times in the business cycle.
Unshaded (white) portions above suggest no clear pattern of over- or under-performance vs. broader market. Double +/- signs indicate that the sector is showing a consistent signal across all three metrics: full-phase average performance, median monthly difference, and cycle hit rate. A single +/- indicates a mixed or less consistent signal. Annualized returns are from 1962-2020, represented by the performance of the largest 3,000 US stocks measured by market capitalization. Sectors are defined by the Global Industry Classification Standard (GICS®). Source: Fidelity Investments (AART), updated as of March 31, 2021.

While there are investment moves you can make in advance of a recession, it can also be a risky time to pursue higher yielding assets. Rather, consider reducing risk by diversifying your portfolio with bonds and cash. The late or "pre-recession" phase of the business cycle is historically a time of abrupt and unforeseen market moves. Also, loading up on the asset classes that have historically delivered the highest returns during recessions may mean adding more exposure to assets that may be among the weakest performers when recession gives way to renewed economic growth during the early cycle that follows a recession.

Fear fighters

To help manage the anxiety and fear that may arise from watching the market and economy as they move fitfully toward recession and the eventual start of the early cycle, it's helpful to have a long-term asset allocation plan as part of a broader financial plan. An appropriate asset allocation includes a mix of stocks, bonds, and cash that aligns with your goals, time horizon, and your ability to manage risk. Your plan can help you avoid emotional overreactions to volatility so you can stay on track toward your long-term financial goals.

What that plan looks like may depend on who you are. For investors who are a decade or more from needing the money in their portfolios to help pay for their living expenses in retirement, recession-related volatility may represent a chance to buy high-quality stocks at discount prices in hopes that they will rise as times improve. However, the entry into recession may have more implications for the portfolios of those near or in retirement who may not feel that they can afford to wait for an eventual recovery in the value of their stocks.

While individual investors should be cautious about making changes to their asset allocations during the late and recession phases of the business cycle, professional managers such as the investment team at Strategic Advisers LLC do adjust the portfolios they manage to reflect their views about where the economy is in the cycle. These so-called cyclical allocation tilts involve carefully adding or reducing exposure to various categories of stocks, bonds, and short-term assets. Adjustments of these sorts typically only represent a small part of each portfolio and are only made within the context of a long-term strategic investment strategy. That's because the forces that move markets are constantly in motion and the investments that perform best have historically varied with the expansion and contraction of economic activity.

This chart shows how a 50/40/10 portfolio has historically performed at various times in the business cycle.
Past performance is no guarantee of future results. Asset class total returns represented by indexes from Fidelity Investments, GFD, and Bloomberg Barclays. Fidelity Investments proprietary analysis of historical asset class performance is not indicative of future performance. Source: Bloomberg Barclays, Fidelity Investments (AART), as of March 31, 2021.

Over time, saving and investing regularly and establishing and maintaining an appropriate asset mix helps investors succeed. Getting started or refining your plan? Start with your goals. Try our online tools in the Planning & Guidance Center. Or for help, consider a Fidelity professional.

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The views expressed are as of the date indicated and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author, as applicable, and not necessarily those of Fidelity Investments. The third-party contributors are not employed by Fidelity but are compensated for their services.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

As with all your investments through Fidelity, you must make your own determination whether an investment in any particular security or securities is consistent with your investment objectives, risk tolerance, financial situation, and evaluation of the security. Fidelity is not recommending or endorsing this investment by making it available to its customers.

Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

High-yield/non-investment-grade bonds involve greater price volatility and risk of default than investment-grade bonds.

While it may seem appealing to look at bonds that offer higher yields, investors should consider those higher yields to be a sign of potentially greater risk. Below are some of the potential risks involved with high yield investing.

Default risk - The risk of default on principal, interest, or both, is greater for high yield bonds than for investment grade bonds.

Credit risk - High yield bonds are subject to credit risk, which increases as the creditworthiness of the issuer falls. It’s important to pay attention to changes in credit quality, as less creditworthy bonds are more likely to default on interest payments or principal repayment.

Business cycle risk - High yield issuers typically have riskier business strategies and more leveraged balance sheets, exposing them to greater risk of default at times of a downturn in business conditions.

Call risk - High yield bonds are more likely to have call provisions, which means they can be redeemed or paid off at the issuer’s discretion prior to maturity. Typically an issuer will call a bond when interest rates fall, potentially leaving investors with capital losses or losses in income and less favorable reinvestment options. Prior to purchasing a corporate bond, determine whether call provisions exist.

Make-whole calls - Some bonds give the issuer the right to call a bond but stipulate that redemption occurs at par plus a premium. This feature is referred to as a make-whole call. The amount of the premium is determined by the yield of a comparable maturity Treasury security, plus additional basis points. Because the cost to the issuer can often be significant, make-whole calls are rarely invoked.

Event risk - A bond’s payments are dependent on the issuer’s ability to generate cash flow. Unforeseen events could impact their ability to meet those commitments.

Concentration risk - Excessive exposure to a specific market sector within any asset class could put investors at greater risk. It’s important to seek diversification across a wide range of issues and industries in order to reduce the negative impact of a default.

Equity correlation risk - The perception that high yield issuers may have trouble generating sufficient cash flow to make interest payments could make them behave like equities. In some cases, high yield bonds may fall along with equities during an economic or stock market downturn. This is a concern for investors using fixed income as a hedge against equity volatility.

Liquidity risk - High yield bonds that may have been easy to buy or sell when market conditions were calm can suddenly become very difficult to sell when volatility increases. Typically, the market for high yield bonds is less liquid than the market for investment grade or government bonds.

Interest rate risk - Although high yield bonds have relatively low levels of interest rate risk for a given duration or maturity compared to other bond types, this risk can nevertheless be a factor. As with all bonds, a rise in interest rates causes prices of bonds and bond funds to decline. Because credit and default risk are the dominant drivers of valuations of high yield bonds, changes in market interest rates are relatively less important. At the same time, a tightening in monetary conditions that usually accompanies a rise in the general level of interest rates may cause a lagging reaction by weaker credits because of their inability to find sufficient funding, which in turn weakens the balance sheet of the high yield entity.

Higher transaction costs - Due to a typically large spread between bid and offer prices, and higher transaction costs associated with less liquid securities, trading high yield bonds can be costly.

Research and monitoring demands - Current and accurate information can be more difficult to obtain for high yield bonds. Investors should conduct due diligence as they consider investment strategies and closely monitor the changing financial condition of the issuing company.

Foreign risk - In addition to the risks mentioned above, there are additional considerations for bonds issued by foreign governments and corporations. These bonds can experience greater volatility due to increased political, regulatory, market, or economic risks. These risks are usually more pronounced in emerging markets, which may be subject to greater social, economic, regulatory and political uncertainties.

You could lose money by investing in a money market fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund and you should not expect that the sponsor will provide financial support to the fund at any time.

High yield/non-investment grade bonds involve greater price volatility and risk of default than investment grade bonds.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

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