Skip to Content
US Videos

Is It Time to Recession-Proof Your Investment Portfolio?

Here's what investors who are worried about a recession should consider today.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Inflation and rising interest rates have rocked the stock and bond markets this year, and lately, another risk factor has emerged, recession. Joining me to discuss why the R word is coming up and how to protect your portfolio against it is Christine Benz. She is director of personal finance and retirement planning for Morningstar.

Nice to see you, Christine.

Christine Benz: Hi, Susan. Good to see you.

Dziubinski: Christine, are we seeing any signs of recession yet?

Benz: Well, a key thing that market watchers have been keeping an eye on is the yield curve. In a normal shaped yield curve, you see that yields slope up to the right, and that means that very short-term investors get paid less in terms of their yield than longer-term investors. Longer-term investors should get paid more because they're taking on more risk. One thing people have been looking at is that we've been seeing a little bit of a flattening of the yield curve recently, indicating that long-term investors are willing to accept lower yields or yields on par with what shorter-term investors are getting. And that has historically been a pretty good harbinger of economic downturns, economic weakness. When we've seen the yield curve flatten or certainly invert, that has tended to predict recession because it means that long-term bondholders are expecting yields to decline, which often happens in a recessionary environment. So, we're not in a full-on yield-curve inversion yet, but it's something to keep an eye on. It's something that has had economists a little bit concerned that further out into the future, there may be some recessionary pressures on the economy.

Dziubinski: Talk a little bit about some of the fundamental reasons that the economy would go into a recession, because it seemed like the bigger concern for a while was the economy being overheated and contributing to inflation. So, for many investors, maybe this talk of a recession is seemingly coming out of nowhere.

Benz: That's true. And there are a couple of things, I think, to keep an eye on, a couple of fundamental underpinnings for some recessionary conditions. The big one is that the Fed is walking a tightrope. So, if they raise interest rates too far, too fast, the risk is that is going to disincentivize economic production, that people will borrow less, they will do less, and that will put the brakes on the economy. So, that's a big risk factor. Another one is inflation. That if we continue to see inflation that we will see consumers pull back on spending, and that will potentially be another thing that could contribute to a recessionary environment. Those are a couple of things that have economists watching closely. But you're right, Susan, inflation and interest rates have been really the main things that everyone has been watching. It's a little bit surprising to hear the recessionary talk now.

Dziubinski: And as you just mentioned, investors are trying to balance a lot of these risks, right? They're trying to balance the interest-rate risk of their portfolio, the inflation risk of their portfolio. So, now, if they want to go in and figure out, "OK, can I recession-proof my portfolio?" What are some things they could be thinking about or considering?

Benz: Well, historically, high-quality bonds have been pretty good ballast for stocks in recessionary environments. So, we've seen this again and again over the past several decades, where bonds are a good thing to own in a recessionary environment. The trouble is, bonds are a bad thing to own in a rising interest-rate environment, which is what we've had so far this year. So, I think it doesn't make sense to completely disengage with bonds for the reason that they do tend to be pretty good protectors in recessionary environments.

Dziubinski: And anything on the stock side?

Benz: Well, a couple of categories I would make sure that your portfolio includes. The key one would be companies that make goods that people need no matter what is going on with the economy. So, that would be consumer staples, companies that make toilet paper and paper towels and diapers. Also, pharmaceuticals makers tend to fare well in such an environment. Utilities would tend to fare pretty well. So, the good news is that those companies are pretty well represented when we look at major market indexes. You probably have them in your portfolio today.

Dziubinski: Let's look at the flip side, which investments might be a little bit more vulnerable in an economic slowdown or recession?

Benz: Sure. A lot of the things that would tend to be vulnerable are the very categories that have performed super well year to date. So, anything that's very cyclical in nature--basic-materials companies, energy companies, they're very, very leveraged to what's going on in the economy. They will tend to behave poorly in a recessionary environment, which I think is a good indicator or a good sort of encouragement to not overdo those investments in your portfolio. Even though we've seen them perform very well, they could be vulnerable in a recessionary shock.

Dziubinski: Christine, let's pan out a little bit beyond the portfolio and talk about what things should investors be thinking about when it comes to their entire financial plan if they're concerned about a recession.

Benz: A couple of things, Susan. I would say check your liquid reserves. If you're a working person, make sure that you have that emergency fund in place. We've seen the employment market be very, very strong, but that can turn in a hurry in a recessionary environment. So, you want to make sure you have that buffer on hand. For retirees, I like the idea of them holding at least six months, but maybe more like two years' worth of portfolio withdrawals in cash investments. They're there to serve as a buffer if the stock market goes down, if bonds continue to be jostled around. So, check up on that. And then, I think also to be circumspect with respect to taking on new financial obligations. So, if you're in the market for a home, for example, just making sure that you're not taking out more of a loan than you can really afford to be a little bit careful about the totality of your financial plan. It seems prudent at this juncture.

Dziubinski: Well, Christine, thank you for your time today and helping us walk us through a little bit about this potentially new risk factor that investors need to weigh now, the possibility of a recession. We appreciate your time.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.