4 RECESSION-PROOF INVESTING STRATEGIES
By: J Scott
Over the past couple weeks, I’ve spent a good bit of time talking about the economy, where it’s been, where’s it is currently, and where its headed. But, I haven’t talked at all about how we as investors should be changing up our investing strategies to accommodate these economic shifts.
In this article, I want to talk to about that…
There are several areas that investors should be thinking about during negative economic shifts. I’ll cover a few of them here…
As investors, portfolio growth is our long-term goal. And while that doesn’t necessarily change during a recession, there is a lot more risk associated with our investments. Those who are too aggressive risk losing value in their portfolio, and unless you are risk-averse and are willing to accept high risk in order to potentially achieve high reward, adopting a more conservative approach is the best way to reduce the chances of losing a lot of money.
The best way to implement a conservative strategy is to diversify. During most recessions, some asset classes will struggle, while others stay strong. And going into the recession, it can be difficult to determine which asset classes and industries are likely to hold up and which are likely to struggle. In fact, we often see a negative correlation between certain asset classes – one is likely to do better when the other does worse, and vice-versa.
Because we don’t know which asset classes – or which industries or niches within them – are likely to do poorly or do well, the most conservative strategy is to invest across assets classes, industries and niches. In other words, instead of concentrating your portfolio in just one asset class (like stocks, bonds, real estate, businesses, crypto, precious metals, etc), invest across multiple asset classes.
And don’t stop there. If you’re going to invest in stocks, focus on diversified funds instead of just individual companies. Focus on different types of funds as well – small cap, mid cap, large cap and emerging markets.
Likewise if you’re going to invest in real estate. For example, don’t just buy multifamily, but consider owning some commercial real estate as well. Perhaps RV parks or self storage or warehouse space. Use funds and syndications to diversify across these assets without having to put too much into any single investment.
And the same with any other asset class you might invest in as well.
We talked about using diversification to reduce risk above. But, risk reduction also involves reducing risk on the specific assets you choose to invest in.
Before digging in there, let me remind you of one of the more important considerations in investing: Risk and return are intertwined. They are two sides of the same coin. Potential returns increase as risk (potential losses) increase. And potential returns decrease as risk decreases.
The least risky investments – think treasury bonds, savings accounts and CDs – have the lowest returns. The most risky investments – think venture capital, penny stocks, and crypto – potentially have the highest returns.
In order to reduce the risk of losing money during an economic downturn, many investors will focus on investments that offer lower returns, as these investments generally provide lower risk. For example, instead of investing in higher-risk real estate ventures like ground-up development, many investors will focus on lower-risk real estate ventures like stabilized residential assets and triple net leases. These investments won’t make you rich overnight, but will help you maintain your capital to invest when the market is providing more opportunity.
In fact, some investors will put a portion of their portfolio into assets focused on wealth preservation – investments that are unlikely to growth, but also unlikely to see a drop in value. For example, inflation protected securities (TIPS) and inflation-protected bonds (I-Bonds), as well as precious metals like gold and silver.
Next, during a downturn – and especially towards the beginning of a downturn – it’s important to focus on the time frame and time horizon of your investments. Any investments that are scheduled to mature and pay off during the recession are more likely to underperform than investments that will likely last throughout the recession and are scheduled to pay off further down the road.
Additionally, any investment that will generate cash flow through the hold period of the investment is likely to be lower risk than an investment that doesn’t generate cash flow or an investment that may continually require cash infusion to keep it afloat.
For example, a new construction project that is scheduled to finish 12 months from now is likely much higher risk than a tenanted warehouse space that is currently generating positive cash flow. Not only does the new construction project look to complete during the recession – making it harder to sell and capture equity – but if the exit strategy doesn’t work out, the project won’t have any cash flow to cover holding costs or debt service.
Smart investors will always ask the question: If this investment doesn’t play out on schedule because of economic conditions, what is Plan B? Can the investment be held for additional time without significant added risk? Will the investment cash flow and pay for itself during the additional hold period? Is the asset class likely to recover once the economy is in better condition?
Perhaps the most important aspect to any investment – and especially during an economic shift – is the team controlling the investment. Great teams have the ability to forecast changes and pivot when they see those changes coming.
For example, if you are investing in companies – either through the stock market or directly – you should be asking yourself, “What is the management team going to do to ensure that the company survives during the coming recession?”
Likewise, if you’re investing in real estate syndications or funds, you should be asking yourself, “Does the operating team understand the dynamics of economic shifts and are they likely to make good decisions should the market thrown a curve ball?”
Or, if you’re investing in your own deals – for example, either a business you own or real investments you maintain – you should be asking yourself, “Do I have the resources to weather an economic storm and the confidence that I will make the right decisions when the going gets tough?”
The operating team is always the most important part of any deal, and that’s even more true during an economic shift.
In summary, recessions pose a risk to your investment portfolio, but if you understand the trade-offs between risk and reward, you shift expectations to more conservative returns, and you vet your operators well, there’s no reason why an economic downturn can’t be an opportunity to continue to grow your portfolio.
By the way, if you want to learn more about investing strategies and get access to a range of passive investing opportunities from some amazing operators, check out Ashley & J's new podcast, The Passive Investing Show!