How bad could a recession be for my investment portfolio?
Brendan Greenwood CIM, B.Comm | September 4, 2019
Clarifying what characterizes a recession
A recession is considered to have occurred when the economy experiences two quarters of negative GDP (economic) growth. If you have been following the news there is lots of discussion about a slowing economy and concern about the growing trade war between China and the US. The number of times recession has been searched in google spiked in August. A recession in the near future is a real possibility.
Should you be concerned?
Let’s look at the more recent historical data to get a better understanding of how we might expect the market to respond. We’ll use the S&P 500 as a proxy for market behaviour.
Since 1945 the S&P 500 experienced three major declines of more than 40% (see chart to the right). In a previous article I wrote, “A strategy to reduce risk while maintaining your investment portfolio growth” I discussed how bigger investment losses can mean longer recovery times for your portfolio. This is evident when we look at the average percentage decline in the chart and compare it to the average time to recover in months. The recovery time exponentially grows as the losses deepen.
The OPEC oil embargo in 1973, dot-com bust in 2000 and sub-prime mortgage crisis in 2008 respectively each contributed to the three largest S&P 500 market declines over the past 75 years. The average recovery time was 58 months or about 5 years. This recovery time is not so bad if you’re not close to or in retirement. If you are approaching retirement or already there, you should have a strategy in place to reduce your exposure to big losses and mitigate the impact of sequence of returns risk (see chart to right for potential impact). Without an effective strategy you risk having less money to enjoy your retirement or less for your estate to pass onto your children.
Important risk reduction factors
Diversification is the key to protecting yourself against the next recession. This means holding a range of assets with low correlations to each other. A well constructed portfolio can provide the diversification needed to reduce the fall in value of your investments in a recession. During the 2008 financial crisis the S&P 500 lost approximately 50% of it’s value, in comparison the Global Equity Balanced fund category within Morningstar’s data universe, which is diversified across asset classes, geography and sectors recorded a fall in value of less than half that, -22.90%. This fund category also took less than half the time to recover to new highs.
Risk reduction can further be achieved by adding low volatility assets to your investment mix. Historical data shows that lower volatility investments tend to out-perform riskier assets over the long term. They are less responsive to market swings and benefit from falling interest rates generally experienced through a recession when demand for credit is low.
Robert Haugen was a pioneer in the field of quantitative investing and has done significant research that found, contrary to popular theory, low risk stocks produce higher returns. The chart to the right highlights findings from one of his studies that examined the average annualized return of US stocks over 20 years, comparing returns to their respective volatility. He discovered that over the long term less risky (volatile) stocks outperformed.
Risk managers can further reduce risk and enhance return potential by applying a dynamic approach to asset allocation, reducing exposure to riskier assets during periods of sustained market volatility and increasing exposure to riskier assets during periods of market calm. This targeted volatility strategy was discussed in a past article I wrote, “A strategy to reduce risk while maintaining your investment portfolio growth”
Applying a more layered approach to risk management will help alleviate recession concerns. Talk to your financial advisor to learn more about what has been done to protect your investment portfolio from the full impact of the next recession which may not be to far away. Not having a sufficiently layered strategy in place could mean a difference between leaving a legacy and not having enough money to live the retirement lifestyle you desire.
Brendan Greenwood is an Investment Advisor with Worldsource Securities focused on personal pension strategies and leveraging technology to provide progressive institutional style investment solutions for professionally incorporated individuals and business owners.
For other articles authored by Brendan Greenwood on issues impacting business owners and investors see https://www.greenwoodwealth.co/blog.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Neither Brendan Greenwood nor Worldsource Securities Inc or its affiliates provide tax, legal or accounting advice. This material is based on the perspectives and opinions of the writer only and does not necessarily reflect views of Worldsource Securities Inc. The opinions or analyses expressed herein are general, and do not take into account an individual’s or entity’s specific circumstances. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Investments are provided through Worldsource Securities Inc., sponsoring investment dealer and Member of the Canadian Investor Protection Fund and of the Investment Industry Regulatory Organization of Canada.