If you want to know what season we're having, just look out the window. If it's sunny and warm, it's probably summer. But if the wind is blowing colder and the sky is beginning to darken, winter is on the way. The economy has seasons too. Growth in consumer spending and production warms the economy, bringing about sunny financial conditions that often last 3-6 years. But slowdowns, as measured by shrinkage in the gross domestic product, lead to recessions which have lasted 11 months on average since World War II.
At this point, it looks like winter is on its way. The credit crunch that started with the subprime mortgage woes has precipitated a decline in home prices that may lead to the burstage of the housing bubble. And weakness in housing usually dampens the overall economy. We may be on the leading edge of a recession in the US.
So what can you do to help your investment portfolio weather the storm?
- Be balanced. Recessions hit stocks harder than bonds, which tend to do well during downpours. To smooth out stock market declines that come with recession, you could hold a "balanced asset allocation," or a blend of stocks and bonds (or stock funds and bond funds). The mix that's right for you will depend on your financial goals, and the rate of return you've targeted in your overall financial plan.
- Diversify, diversify, diversify. In the last recession, tech stocks got soaked while real estate shone brightly. But trying to call the next hot sector while dodging the doldrums is not a good idea. It's smarter to own a variety of investments ranging from large companies to small, growth and value, both foreign and domestic. Seldom does everything go down at the same time.
- Think "long term." The thought of losing money may make you nervous, but remember that recessions are short term phenomena. While the worst recessions can last as long as two years, your personal investment time horizon - the time until you need to spend your money - may span a decade or more. Don't let short term volatility blow away your long term plan.
Like the seasons that control our weather, the cycle of economic change is a natural part of the climate for investors. It may seem like a good idea to stay out of the weather, but it might be a better idea to plan for the elements - both fair and foul - by investing in an all-weather strategy.