Every economic climate produces winners and losers. In 2008, at the start of the Great Recession, bonds took the top spot. In 2020, the year of the Pandemic, large-cap growth stocks performed the best. The following year it was REITs that produced the highest gains.
In those same years, international, REITs, and global bonds, respectively, claimed the worst-performing investment categories.
The challenge for investors is creating a portfolio that includes winners every year.
Diversification is an effective way to reduce risk and volatility. It can protect investments during a recession because it gives you access to various assets that provide different sources of income and growth.
Diversifying means investing in multiple asset classes. It reduces risk because if there’s a slowdown in one asset category, others may still perform well. The practice will often improve returns over time because it takes advantage of the top-performing asset class each year.
While diversification is a fundamental principle of sound investing, it often gets overlooked or misapplied. Most investors consider themselves well diversified if they hold stocks and bonds or hold positions in various industries across companies of different sizes. While this is the beginning of a diversified portfolio, stopping there can leave you vulnerable, especially during an economic downturn.
How to Effectively Diversify Your Portfolio
Proper diversification requires you to consider all types of investments and their relationship with one another. Some assets move in tandem with each other, while others move in opposite directions. Reviewing an investment’s ability to perform in various market conditions is also essential.
For example, large companies tend to be safer because they have more capital but take longer to modify their course when the economy changes. Smaller companies are more agile but have less capital to carry them through economic difficulties. International and global stocks and bonds do not always move in the same direction as US investments.
Alternative investments can also improve diversification. Real estate, gold, and peer-to-peer lending are options that do not typically follow the stock market performance.
Investing During a Recession
The predicted economic downturn is an opportunity to re-evaluate your portfolio with an eye on diversification. Which investments are most likely to perform well despite high inflation and rising interest rates? What changes can you make to reduce volatility to buoy returns?
Certain industries fare better during economic downturns. For instance, healthcare and consumer staples tend to perform well because demand is more predictable than non-essential products and services. Investments that pay dividends or distributions can also provide stability. Dividend-paying stocks and real estate are effective ways to meet income needs.
Optimal Diversification Helps Manage Risk and Reduce Volatility
Diversification is a central concept in investing. Having the right mix can manage risk and ensure investments are on track for long-term growth. It also ensures your portfolio isn’t too dependent on any particular stock, bond, fund, or industry. The most effective diversification spreads investments around, so no single position significantly affects the value of your entire portfolio.
With a weak global economy, it is natural to be concerned about losing money. However, a proper investment strategy can preserve your wealth regardless of market conditions.
Adding real estate can be an effective strategy to improve your portfolio diversification. It typically provides cash flow through rent soon after closing. And even when property values fall, the investment can be profitable because you buy in at a discount.
If you’re interested in learning more about investing in real estate syndications with McKee Capital Group, watch our introductory video.