Some experts say a recession is imminent. How to create your portfolio

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Months of stock market volatility, rising inflation and rising interest rates have left many investors wondering if a recession is imminent.

The stock market tumbled again Thursday, with the S&P 500 capping its worst six-month start in a year since 1970. Overall, it’s down more than 20% since the start of the year. The Dow Jones Industrial Average and Nasdaq Composite are also down significantly since early 2022, falling more than 15% and nearly 30%, respectively.

Meanwhile, consumer feelings about the economy have plummeted, according to the closely-watched University of Michigan Consumer Survey, measuring a 14.4% decline in June and a record low for the report.

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According to CNBC’s CFO Survey, around 68% of CFOs expect a recession in the first half of 2023. However, forecasts from experts on the possibility of an economic downturn vary.

“We all understand that markets go through cycles and recessions are part of the cycle that we may face,” said certified financial planner Elliot Herman, a partner at PRW Wealth Management in Quincy, Massachusetts.

However, since no one can predict if and when a downturn will hit, Herman urges clients to be proactive and ensure their portfolio is ready.

Diversify your portfolio

Diversification is key when preparing for a possible economic recession, said Anthony Watson, a CFP and founder and president of Thrive Retirement Specialists in Dearborn, Michigan.

You can reduce company-specific risk by opting for funds rather than individual stocks because you’re less likely to feel like a company in an exchange-traded fund with 4,000 others will go bankrupt, he said.

Value stocks tend to outperform growth stocks in a recession.

Anthony Watson

Founder and President of Thrive Retirement Specialists

He suggests reviewing your mix of growth stocks, which are widely expected to offer above-average returns, and value stocks, which typically trade for less than the asset is worth.

“Value stocks tend to outperform growth stocks in a recession,” Watson said.

International exposure is also important, and many investors default to 100% domestic assets when allocating stocks, he added. While the US Federal Reserve is aggressively tackling inflation, other central banks’ strategies may trigger different growth paths.

Check bond allocations

Since market interest rates and bond prices typically move in opposite directions, the Fed’s rate hikes have pushed down bond values. The benchmark 10-year government bond, which rises when bond prices fall, topped 3.48% on June 14, the highest yield in 11 years.

Despite falling prices, bonds are still an important part of your portfolio, Watson said. When stocks plummet en route to a recession, interest rates can also fall, allowing bond prices to recover, which can erase equity losses.

“Over time, this negative correlation tends to show up,” he said. “It’s not necessarily from day to day.”

Advisors also consider duration, which measures a bond’s sensitivity to changes in interest rates based on coupon, time to maturity and yield paid during life. In general, the longer a bond’s duration, the more likely it is to be affected by rising interest rates.

“High-yield bonds with shorter maturities are attractive now, and we have maintained our fixed income in this space,” added PRW Wealth Management’s Herman.

Estimate the liquidity reserves

With high inflation and low returns on savings accounts, holding cash is less attractive. However, retirees still need a cash buffer to avoid what is known as “return-following” risk.

You need to be careful about when you sell assets and make withdrawals as this can hurt your portfolio in the long run. “So you fall prey to the negative outcome of returns that will eat your retirement alive,” said Watson of Thrive Retirement Specialists.

But retirees could avoid tapping into their nest egg in times of deep losses with a substantial liquidity buffer and access to a home equity line of credit, he added.

Of course, the exact amount needed may depend on monthly expenses and other sources of income like Social Security or a pension.

From 1945 to 2009, the average recession lasted 11 months, according to the National Bureau of Economic Research, the official documenter of economic cycles. But there is no guarantee that a future downturn will not last longer.

Cash reserves are also important for investors in the “accumulation phase,” with a longer time to retirement, said Catherine Valega, CFP and wealth advisor at Green Bee Advisory in Winchester, Massachusetts.

I tend to be more conservative than many because I’ve seen three to six months of emergency spending, and I don’t think that’s enough.

Catherine Walega

Wealth Advisor at Green Bee Advisory

“People really need to make sure they have enough savings for emergencies,” she said, suggesting saving 12 to 24 months of spending to prepare for potential layoffs.

“I tend to be more conservative than a lot of people,” she said, noting the popular suggestion of three to six months of spending. “I don’t think that’s enough.”

With additional savings, you’ll have more time to plan your next career move after losing your job instead of feeling pressured to accept your first job offer to cover the bills.

“When you have enough liquid emergency savings, you give yourself more options,” she said.