Key Points
If tough times are ahead, investors will want to build up their cash reserves to buy undervalued stocks.
Companies in certain sectors, notably healthcare and consumer staples, hold up well in adverse economic scenarios.
Dividend stocks may be attractive, as they can generate steady income regardless of macro conditions.
No one can predict when the next recession will occur, but it's coming. History says that the economic cycle ebbs and flows. And without warning, a downturn can happen.
Successful investors are always thinking about what the future might hold. And they adjust their strategies accordingly. Here's how to recession-proof your portfolio before a potential storm comes.
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Add to your cash position
First, take a step back. If you believe that a recession is coming in the near future, it might be a smart move to build up your cash reserves. Instead of allocating the new money that's added to your portfolio to buy stocks, let it sit in cash. This provides the financial capacity to purchase stakes in companies that might be offered at a market discount.
That being said, recessions present compelling opportunities. Even high-quality businesses could start to report weaker-than-expected financial results. Their shares sell off. Investors panic. And what's left are undervalued securities.
If this scenario takes shape, you'll be extremely happy that you prepared by adding to your cash holdings. This puts you in a favorable position to be aggressive, which will benefit your portfolio in the long run.
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Favor high-quality resilient businesses
During recessionary periods, investors would be wise to look at healthcare stocks. Companies like Johnson & Johnson, UnitedHealth Group, and Abbott Laboratories have historically registered steady financial performance. This makes sense: Consumers can't delay spending on healthcare when times get tough.
Another sector to take seriously in adverse economic times is consumer staples. These businesses sell products that people use in their day-to-day lives, so demand is durable and predictable. Coca-Cola, Procter & Gamble, and Kroger come to mind.
Because consumer staples stocks are attractive places to allocate capital, it's also worth considering retailers that are known for consistently low prices. Customers will cut their budgets for discretionary purchases, but they can't do that with necessary items. This benefits businesses that sell these kinds of goods, like Walmart, Costco Wholesale, and Dollar General.
Recessions are also a time to consider dividend stocks, especially those of companies with an impressive history of raising their payouts over time. Some of the businesses mentioned above are Dividend Kings, as they have annually increased their dividends for more than 50 consecutive years. The income stream they produce can provide a valuable return during economic downturns.
It's anyone's guess when the next recession will happen. But the best investors have a clear playbook.
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Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Abbott Laboratories, Costco Wholesale, and Walmart. The Motley Fool recommends Johnson & Johnson, Kroger, and UnitedHealth Group. The Motley Fool has a disclosure policy.
