How to Build a Strong Investment Portfolio in a Recession Year


Many market watchers have been shouting about the storm clouds of recession appearing to be approaching. Without a doubt, the last thing anyone wants is a quick drop as consumer sentiment continues to fade at the hands of the Federal Reserve’s rapid interest rate hikes. Undoubtedly, the Fed has few tools to contain inflation without hurting consumers or jobs. At this point, the timing seems questionable to start investing with your first $10,000, but it might not be a bad idea.

In an 11-month bear market, it seems like the only thing stocks can do is go down. A sharp turn from what was expected of them in the meme stocks era of 2021, when many market newcomers thought stocks could only go up.

While many new investors may feel better about investing after the bear market or recession is over, it should be noted that there are far more long-term gains to be had from braving bear markets. Indeed, buying in the middle of a bear market brings pain. However, in the world of investing, the willingness to feel a bit of short-term pain can be key to improving your shots with a solid risk-adjusted long-term gain.

As the saying goes: no pain, no gain.

Know your risk tolerance

Buying stocks was much easier in 2021. That said, such quick and easy gains ultimately ended in tears for many who let greed take control. Undoubtedly, many growth hunters are scarred by this year’s bear market. Other investors who have stayed in their lanes (by staying diversified) have learned the value of patience and finding stocks that are not only profitable (sustainable), but cheap relative to historical and sector averages and in line with their personal risk tolerance.

While it may seem wise to hide your $10,000 in a risk-free, interest-bearing instrument (this may be fine if you’re not prepared to take any stock market risk), I’d say it’s worth getting diversify across asset classes, especially if you’re a young investor who wants to stay invested for the next five to ten years.

Indeed, the time horizon plays a major role in how you should invest your $10,000. If you are approaching retirement or have large expenses (think mortgage) planned for the next three years, it may be a good idea to limit your exposure to risky assets (think stocks and REITs), even if it means giving up any glorious bargains in the stock market that you can see today.

The fact remains that no one can say where the stock market will be from one year to the next. The longer your investment horizon, the greater your ability to take risk and the more willing you should be to buy stocks in this bear market.

In this article, we’ll focus on building a $10,000 portfolio for investors who are prepared to hold out for at least five years.

Balancing risk with reward

In a year like 2021, it’s easy to chase rewards with minimal downside risk in mind. This year, it’s more about risk than reward. If you’ve been at it for at least five years, however, you should aim to find the risk/reward ratio that’s right for you. Plus, just because you can tolerate risk doesn’t mean you should back the truck up on hard-hit tech companies like Peloton (NASDAQ: PTON) with the hope of a clear rebound.

Investors with appropriate time horizons should take smart, calculated risks. As for Peloton, questions remain as to whether the company’s debt and cash burn will prevail. With deep headwinds, things could easily get worse before they get better, and it doesn’t matter that the stock has already lost more than 95% of its value. A crashed stock does not indicate the value to have. On the contrary, investors should proceed with caution.

On the other hand, investors with long-term horizons should not hesitate to take risks after stocks have already slipped in a bear market. By playing too carefully with defensive stocks with dividends, like Crown Castle International (NYSE: CCI) at 35.5 x earnings, one may run the risk of overpaying. It doesn’t matter if you’re looking at the most recession-proof company on the planet; if you pay too much for a stock, you can still lose money.

In the middle we have companies like Microsoft (NASDAQ: MSFT) which went through the downturns to emerge higher a few years later. Microsoft is one of the high quality companies that can become more dominant when the “economic tides” fall. Microsoft has mastered the art of taking market share and entering new markets to maintain its long-term growth rate.

Spread wealth across different risk appetites

If you’re an investor with $10,000 to put to work, Microsoft is probably a good choice for a top-notch holding. Personally, I wouldn’t mind putting about a third ($3,000) on the name. Your allocation will (and should) differ based on various factors, including your tolerance for day-to-day fluctuations.

Microsoft is a truly wonderful company, but hectic days can be too much for your stomach! That’s why I can’t stress this enough: know your risk tolerance and don’t be afraid to leverage a cost-average (DCA) approach if you’re new and need a gauge. volatility you can handle.

DCA involves buying your place in your desired allocation (say 30% of the money you plan to invest) over several months (or quarters).

It’s wise to diversify, but at the same time, over-diversifying can have its downsides and limit returns. Microsoft is a great company. Additionally, MSFT is arguably a baby thrown out with the bathwater at around 25x tracking earnings, given the momentum of its Azure cloud business and the long-term benefits of gaming.

As for the rest of the portfolio, I would personally look to diversify into high-quality, moderate-value consumer staples (think McDonald’s (NYSE: MCD)) that can weather a recession with less downside than market averages. They’re not exciting, but they’re great portfolio stabilizers, in my opinion.

How to Build a Strong Investment Portfolio in a Recession Year

What about risky games?

If you’re young, with a long-term horizon, looking to add warmth to your portfolio, and more than willing to face some serious downside risk, risk plays might make sense with a small percentage of your capital. Personally, I would limit such exposure to 5%.

Fallen companies like Peloton are down for good reasons. When the momentum is so biased downward, it can be difficult to break a cap. If you like the product, have confidence in the management’s abilities, and are willing to do your due diligence, scouring the ground for possible “cigar butts” might not be the worst idea in the world.

Before you do, however, I encourage you to know yourself as an investor and consider the risks we will all face in 2023.

Disclosure

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


nasdaq
Not all news on the site expresses the point of view of the site, but we transmit this news automatically and translate it through programmatic technology on the site and not from a human editor.
Back to top button