I’ve heard some questions around “recession-proof investments”. Is there such a thing?
I’m not sure, but in my opinion, we’re focusing on the wrong thing.
Your investments aren’t meant to be recession-proof. There is something in economics called “no free lunch” or the classic saying we all know is “you can’t have your cake and eat it too”.
You can’t get something for nothing.
Your investments can’t get a return without risk.
In investing, risk is return. The higher the volatility risk, the higher the EXPECTED return - otherwise why would you take that risk? The higher return compensates you for taking that risk.
There are many products out there that will protect your investments from loss, but this will cost you in insurance fees (which in itself is a loss) and will have a lower expected return.
These products look quite attractive when stocks are down, but they can’t keep up when stocks are rising, which is the majority of the time.
Although you can’t recession-proof your investments in my opinion, you CAN recession-proof your finances. The idea behind this is you don’t need to protect your investments from loss, because you’ll never have to sell out of them. This comes from having a strong financial foundation.
When you don’t have to sell your investments, although they have paper losses, they’ll remain invested for a stock market recovery.
Here are three ways to recession proof your finances:
1. Stable income
Income is oxygen for young professionals - without your income, you’re likely in a bit of trouble. Building stability in your income avoids the need to rely on savings and allows you to invest more.
Here are a few ways I think about creating stability in your income:
Industry specific - Is your job in an industry that is generally recession proof? We’ll always need doctors, so I would say a physician's job is oftentimes insulated from recessions. If you’re in the oil and gas industry, your position may be a bit more volatile.
Employee specific - It is important to grow your skills as an employee to make yourself irreplaceable. Maybe you're in an industry that is a little more volatile, but if you bring enough value to the company, then you can protect yourself by growing your skills.
Back-up options - How quickly would you be able to get another job that you have the skills for? Or another back-up option is starting a business or utilizing other skills to bridge the gap before your next job.
I feel like Jeff Probst in Survivor by saying “in this game, fire represents your life” but in this case replace “fire” with “income”.
Stabilize your income through your skills and / or industry, and have a plan b.
2. Cash or access to cash
I won’t go on and on about emergency funds, but they’re important, and exactly for this reason. If a recession hits, or you lose your income, or a big expense pops up, you don’t want to be selling investments when they’re down.
To avoid selling investments, you can use an emergency fund to bridge the gap or create a buffer from your investments. The size of your emergency fund should match the riskiness of your financial situation.
If you have a really stable income in a stable profession, have a backup income source AND a spouse with the same situation - you can probably keep your emergency fund a bit lower.
If you’re in the opposite situation, you can add some protection to your less-stable income by having a higher emergency fund to create a couple layers of defense before having to touch your investments.
The second part of this paragraph is “access to cash”. The best way to do this is by actually having cash available.
But another way to add a buffer is through access to cash i.e. debt. You can do this through a credit card, personal loan, home equity line of credit, 401(k) loan, or another option.
I’m not condoning this for everybody - but it does allow a short-term buffer. This way, you wouldn’t have to sell investments during a loss and take them out of the market before a recovery. This can become a slippery slope if it isn’t a short-term strategy, as the 25%+ interest rates on certain loans can quickly overcome any benefit of staying invested.
To summarize, create a buffer by having available cash so that you don’t need to sell investments in a downturn.
3. No high interest debt
I’m a fan of debt, but not when there is a high interest rate. There are two big reasons this can really hurt you during a recession:
Interest - Obviously as the name suggests, high interest debt has high interest. This is eating away at your money each month by having to pay the bank for loaning you the money. This can add up fast and start to snowball when you add both interest and fees.
Cash flow - Cash is really important as I’ve explained in the first two paragraphs. Losing cash flow to make minimum payments on your debt, of which the majority is going to interest, can get you nowhere, fast.
Getting rid of this debt will increase your cash flow due to avoiding having to make payments, as well as interest and fees.
When you invest money, you have to go through the exercise of thinking through how long you can keep it invested.
If your finances are not strong enough to withstand a recession, and if you don’t have any back up plan devised for getting through one, then you shouldn’t be investing.
The purpose of your investments is not to protect you from the risk of losing money. It is there to take on risk and reward you for that risk.
Instead of trying to find a recession-proof investment, recession-proof your finances, and then invest any excess.