Help Desk: Five ways to invest confidently in the face of a recession

By Jason Policastro, as published in the Baltimore Business Journal

Will there be a recession? How long will it last? How will it impact markets? These questions are on the minds of most investors as the economy moves closer to recession and the business community prepares for year-end planning season.

The good news is that there are ways to strengthen your financial position regardless of what awaits us in the near term. Here’s a list of five action items that will serve you well during the upcoming economic downturn, regardless of how hard or soft the economic landing turns out to be.

Supercharge your emergency fund

Emergency funds are the backbone of a healthy financial plan. They provide access to liquidity when the inevitable surprise costs pop up – your hot water heater breaks, your car needs repairs, or the roof springs a leak. Having an emergency fund with three to six months’ worth of expenses prevents you from tapping into your long-term investments, a must when building wealth.

It’s imperative that these funds are easily accessible when you need them, so they cannot be locked up in illiquid investments. This liquidity comes at a cost, meaning the yield on a liquid savings or money-market account won’t be as high as what you could expect from other types of investments. Yields are creeping higher for these types of accounts as interest rates increase. According to Bankrate.com, high-yield savings accounts are approaching almost 3%, higher than they’ve been in a more than a decade. Fully fund your emergency fund and make rising rates work for you while maintaining liquidity in an uncertain environment.

Harvest your losses

Last year brought substantial market gains, and in 2022 markets have been volatile. But with this downward trend comes opportunity – harvesting your losses to offset capital gains in your portfolio.

If an investment in your portfolio is losing money, and you have gains in other investments in your portfolio, you can sell the investment with the loss and use the proceeds to offset some of the taxable gains. There’s no limit on matching losses to gains. If there are no gains, all losses can be carried forward for use in future years. Then you can reinvest the cash from the sale into a different security that fits into your overall allocation.

The benefits of tax-loss harvesting could be substantial in your taxable accounts. Current market conditions make this an ideal time to evaluate your portfolio for losses that could be used to offset gains this year and beyond. Some investments, particularly mutual funds, could have a taxable distribution this year, despite negative performance, making tax planning even more important.

Dollar-cost averaging for tomorrow

Dollar-cost averaging is just another way of saying you’re making ongoing contributions to your retirement or other investment accounts on a regular basis. This approach takes the emotion out of the equation, since you know how much you’re contributing each period. Automating the process with automatic deposits on payday is the best approach, because you’ll never even notice the money.

When stocks are down, you’re buying them at a discount, so you’re getting more shares with the same amount of money. When the market eventually recovers, you’ve amassed a larger number of shares that are now on the rise. Disciplined, consistent investing like this is how wealth is built over time. Take advantage of cheap markets to plant seeds for tomorrow.

Go beyond stocks and bonds

Alternative investments have been a bright spot at a time when most other investment options have been challenged. In particular, private credit, private real estate, private equity, and real assets have helped blunt the impact of the stock market decline in 2022.

In his book, “Pioneering Portfolio Management”, the late investing legend David Swensen pulled back the curtain on his approach to endowment investing, which had produced outsized returns for the Yale University endowment over many years. In addition to broad diversification across asset classes and low allocations to assets with low expected returns, Swensen included high allocations to private equity, private real estate, and other alternatives in his strategy.

No one knows exactly what’s coming, but a comprehensive approach to asset allocation that includes alternative investments should serve investors well in the months and years ahead.

Reset equity expectations

Renowned Wall Street trader Gerald Loeb once said that “the art of investing is being able to adjust to change.” This resonates particularly well as we’ve watched the dynamics of the stock market turn on their head this year.

If a recession arrives, the type of large-cap growth investments that powered the market for years leading up to 2022 could be especially vulnerable. There are some long-term secular trends under way that could reshape markets in the years ahead, but that doesn’t mean investors should avoid equities going forward.

Successfully navigating an equity market in flux requires a diversified portfolio and a long-term financial plan designed to help you succeed through up and down markets. Talk with your financial advisor about what lies ahead and how you can put yourself in a position of strength in the face of market weakness.

Jason Policastro is a private wealth advisor at Cornerstone Advisory and the chair of the Communications Committee at the Financial Planning Association of Maryland.

As always, if you have any questions or would like to have a conversation, please reach out to us or your portfolio manager.