Opinion
Not if, but when: How to prepare for a recession as a first-time investor
Wijith Wijeyasiri
Money contributorWhether you’re turning on the news, reading the paper or checking social media, it’s difficult to avoid the morbid discussion of a global or national recession, especially as New Zealand has already officially entered a downturn.
As if the soaring cost of living wasn’t enough, central bank tightening and a pessimistic housing market have been front and centre in driving a possible economic recession.
Younger Australians have never had to tussle with a potential recession, so it’s important to understand what it might mean for your money.Credit: Louie Douvis
But what about young Australians? We have never managed our investments and our money during an equivalent period of economic volatility and risk – during the GFC of 2007-2008, all I was worried about was whether my football uniform had been washed for the weekend.
As first-time investors, it’s important to realise and understand what a recession means for our individual investment portfolios, but also the repercussions that could be felt across all financial services.
As scary as they may seem, recessions are an unavoidable element of the economic cycle, defining a prolonged period of economic decline often characterised by consecutive quarterly declines in gross domestic product (GDP). In 2023, the combination of tightening monetary policy, geopolitical tension, supply chain shocks and soaring inflation have all contributed to the situation we now find ourselves in.
During a recession, investors will need to brace themselves to weather the negative impacts of economic downturns. However, there are strategies and solutions to protect our wealth and even capitalise on opportunities. Equity markets are generally prone to the highest levels of volatility during a recession as individual stock prices fall due to the uncertainty of company valuations.
Those classed as “growth” stocks are almost certainly poised to lose value and make a dent in your portfolio as, during a recession, the fuel for growth is limited as cheap money isn’t available.
To combat this, investing in “quality” stocks can provide a great defensive mechanism for investors. Seek companies that do not depend on economic growth to thrive. These businesses have high recurring revenue, strong cash flow and competitive advantage which allows them to be less susceptible to external market volatility.
Many examples of quality stocks are businesses with subscription-based models, think Netflix, Amazon and Spotify. These stocks will allow your portfolio to maintain its value, and more often than not have the ability to provide stable dividends to shareholders.
You may have heard the phrase “cash is king”, an adage that becomes more relevant during economic volatility. As parts of your portfolio may be exposed to serious negative impacts, it may be a good idea to siphon a portion of your investments not into cash directly, but into a money market fund that is not tied to equity or bonds.
A money market fund or ETF invests in highly liquid, short-term debt securities such as cash, cash equivalent securities or debt-based securities with high credit ratings and short-term maturities including government securities and treasury bills or notes. As such, money market funds present low capital appreciation but also an extremely low-risk profile making them a suitable place to park cash for short periods, whilst still generating income.
Buy low, sell high
A recession can also offer investors who are new to the market, an aggressive opportunity to dive straight into assets that will offer more upside potential for a lower price. Investors can buy stocks that have fallen dramatically and capitalise on the economic rebound following a recession.
However, the “buy low, sell high” method depends on certainties, and that’s something a recession will not give you. Often the risks involved can overwhelmingly outweigh the positive outcome, so choose wisely and conduct thorough research when considering an aggressive approach.
It’s important to note a recession doesn’t last forever. For most of us, the biggest challenge will be the psychological battle of instincts. Our mind analyses risks and tells us to jump ship when a recession hits – whether that’s selling our equity or sticking our heads in the sand.
Remember that investing is not a short-term game. The recession will end – staying true and holding investments over extended periods of time will be the most fruitful and teach us the most about the economic environment.
Building a well-rounded portfolio – one that balances its exposure to capital growth as well as income – is key in times such as these.
An ability to be nimble, vigilant and educated on the situation will go a long way to ensuring your wealth is protected.
Don’t stick your head in the sand and wait – the proactive investor will almost certainly be better equipped to weather the storm ahead.
- Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
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