How To Make Money During A Depression – The current US economic expansion is now the second longest in history. While another recession may not be inevitable, it will happen at some point.
So let’s take a look at how to prepare your portfolio for a recession, including what specific sectors and asset classes are best for retirees who care about safe and stable sources of income.
How To Make Money During A Depression
Most investors break down their portfolios into three types of major asset classes: cash, bonds, and stocks. Each group has its strengths and weaknesses, both in the long run and in recession and bear market.
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Cash and cash equivalents (such as savings accounts and short-term US treasury bills) are a way to provide short-term liquidity so that you have enough cash on hand to cover your upcoming expenses.
While these investments offer little potential for profitability or appreciation of capital (and are poor hedges against inflation), they can play a useful role in providing risk-free storage for the assets that you will definitely need in the near future.
Bonds are the second lowest risk asset class and are usually a very reliable source of steady income during a recession. The downside of most bonds is that they do not offer protection against inflation (as interest payments are fixed) and their value can be very volatile depending on prevailing interest rates.
However, the reason financial advisers usually advise older investors to own at least some bonds is because they are less correlated with so-called “risk assets” such as stocks. In fact, bonds can provide a good buffer for a portfolio in times of crisis.
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For example, according to MFS Investments, global bonds rose 12% in 2008 and 8% in the 2000-2002 tech crash. However, as you can see in the fixed income table below, not all bonds are created equal.
In 2008, high yield bonds fell by 26.2%, emerging market debt lost 12% and Treasuries gained 13.7%. These losses are still significantly better than the 2008 S&P 500 return of -37%, but risk-averse investors lured by lower bond volatility still need to be selective in their purchases.
First, bonds, especially government bonds, are considered safe assets (US bonds are considered “risk-free”) with a very low risk of default. So, during a recession and bear market, investors tend to shift money to lower risk assets, which raises their price.
The second reason bonds often perform well in recessions is that interest rates and inflation tend to drop to low levels as the economy contracts, reducing the risk that inflation will undermine the purchasing power of fixed rate payments. Moreover, when interest rates fall, bond prices tend to rise. This is because newer bonds are issued at lower returns, so the actual value of existing bonds also increases to match current market conditions.
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Finally, we come to shares that are ownership interests in companies. Compared to bonds, equities offer advantages in terms of better long-term total returns, protection against inflation, and income generation (many offer higher dividend yields than bonds and increase their payouts over time). The downside is that they are ‘risk assets’ that generally fall out of favor during a recession and can change value rapidly in the short term.
However, while it may seem intuitive that investors preparing for a recession should consider overweighting cash and bonds, there is one potentially compelling reason to keep holding stocks regardless of age.
In particular, equities have been the best performing asset class since 1900 both in absolute absolute returns and, importantly, in inflation-adjusted total returns.
Unless your retirement portfolio is extremely large, most investors still need the component power of the stocks working for them to ensure they do not run out of money in their retirement.
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Let’s take a look at what stocks investors should own to minimize risk during a recession.
There are three key ways that investors can “recession hedge” some stocks in their portfolios. The first is to invest in stocks that have historically generated lower than average volatility but higher overall returns compared to the wider market.
High dividend yield shares have historically proved to be one of the most successful asset classes and have been significantly less volatile. For example, from 1928 to 2017, with the Great Depression and two other market crashes of more than 50%, 40% of the top-performing stocks in the S&P 500 Index generated cumulative returns of around 11.2% per annum (see quintiles 4 and 5 below).
More importantly for conservative investors, they did so while enjoying over 30% less volatility (lower standard deviation) than stocks that did not pay dividends. As a result, their risk-adjusted returns, as measured by the sharpening factor, were significantly better over the period.
Cause And Effects Of The Great Depression T Chart Storyboard
A second way to confirm a recession in your stock portfolio is to focus on blue chip stocks that are seeing dividends, such as the aristocrats dealing with the dividends. Aristocrats are companies on the S&P 500 index that have increased their dividends for at least 25 consecutive years and thus have demonstrated their ability to maintain stable business models, strong balance sheets, and a conservative corporate culture.
Due to their resilience, aristocrats actually managed to generate positive returns during the 2000-2002 stock bear market and fell by just 22% in 2008, compared to the 37% drop in the S&P 500 index. This shows the strength of investing in safe blue. dividend growth chips in troubled economic times.
More broadly, dividend-paying stocks have consistently shown much less volatility over many decades than non-dividend-paying companies. The chart below shows the final annual 3-year standard deviation (volatility) of each group. You can see that the blue line that represents those paying dividends has been lower than the gray (not paying dividends) almost every year since 1927.
Since dividends are usually much more stable than gains and stock prices, they help create a more stable basis for total return.
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A final way to lower the risk of a recession, beyond focusing on high-quality equities with rising dividends, is to consider tilting your equity portfolio towards defensive sectors. Defense sectors are those whose business models are least affected by the recession as they provide essential goods and services that consumers continue to buy even in times of crisis.
Historically, consumer staples, healthcare, utilities and telecommunications have been the sectors most resistant to recession. Their sale is very little affected by the state of the economy, as they sell basic products and services such as food, electricity, wireless internet and medicines.
As you can see, in 2008 these sectors, while still declining, fell far less than the S&P 500.
Investors interested in keeping their capital can tip their equity holdings towards these more defensive areas of the market. However, we prefer to invest no more than 25% of our portfolio in one sector to maintain a reasonable diversification. You never know which sector will perform the best (or worst) in any given period.
A Peddler Selling Apples During The Great Depression Of The 1930s. Stock Photo
Now that we know the basics of what assets we can have to help protect our portfolio from recession, including the importance of long-term investing in high-quality equities with increasing dividends, how to build a recession-proof retirement portfolio?
Everyone’s individual needs are different, so it’s often a good idea to consult a certified, paid financial planner to develop a personalized asset allocation that’s right for you.
A key part of the process is selecting the right combination of cash, bonds and stocks to hold that will maximize your chances of meeting your long-term financing needs. With that in mind, there are a few general principles that self-appointed investors can look at to prepare for a recession.
The first thing to know is how often recessions happen and how bad they can be. A study by the Federal Reserve of St. Louis of 2016 showed that there has been no statistically significant correlation between the duration of expansion and the risk of a short-term recession since World War II (WWII).
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In other words, expansions do not necessarily die of old age. Usually, they must be caused by some external shock. Another important thing to note is that since World War II, recessions have usually been mild and short-lived.
For example, in the modern era (since 1990), the recession usually lasted less than a year and caused GDP to fall by less than 1.5%. The financial crisis, which froze viable credit markets and caused the worst recession since 1945, was also extremely long, lasting 18 months.
So while no one can predict when the next recession will come, the good news is that they don’t happen often, and when they do, the economy starts to recover within a fairly reasonable amount of time. The key is to stay calm and stay on course.
Including the Great Depression, the US had 10 bear markets since 1926 (20% or more decline from the previous market peak). The average duration was 24 months and the average decline in the stock market was 45% on the J.P. Morgan Asset Management.
The Great Depression.
Fortunately, stocks tend to recover quickly, with the average time to return to all-time highs after a revision (down 10% or more from the previous market peak) is just 10 months.
Bear markets usually go on
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