4 Investments to Avoid During a Recession

In recent years, the Federal Reserve has tried to balance the difficult task of slowing the economy to bring down the highest inflation in decades while also trying to avoid tipping the economy into recession. So far, so good, but recent economic data has shown some areas of concern, and a soft landing for the economy is far from guaranteed.

If a recession hits, here are some investments you should avoid.

Recessions can be hard to predict and even harder to navigate. Investments you traditionally consider safe may actually expose you to greater risk depending on the economic environment.

1. High-yield bonds

Your first instinct might be to dump all your stocks and invest in bonds, but high-yield bonds can be especially risky during a recession.

High-yield bonds, with credit ratings below investment grade, are riskier than government debt and are highly susceptible to market declines. The companies issuing them are often smaller, indebted, and generally of lower quality, and in times of market uncertainty, they may be more vulnerable to trouble.

2. Highly leveraged stocks

Companies that have high levels of debt on their balance sheet should be avoided during a recession. A highly indebted company will likely see its stock price fall during a recession. If a company has trouble repaying its debts due to reduced demand and a general economic slowdown, its stock price could fall quickly, and the company could even file for bankruptcy.

While indebted companies may struggle during recessions, which may later prove to be an investment opportunity, a defensive investor should stay away until the company faces clear business challenges that it needs to overcome.

3. Consumer discretionary goods companies

Consumer discretionary stocks are popular during times of prosperity, but their goods and services extend beyond everyday needs, such as utilities and healthcare. Well-known consumer discretionary companies include Tesla and travel companies, such as cruise lines or airlines.

This sector could be particularly vulnerable to recessionary pressures as the economy slows and people start spending less. Consumer goods companies are subject to more drastic changes with consumer sentiment and economic cycles, which can worsen in times of financial uncertainty.

4. Other speculative assets

Speculative assets are high-risk, high-reward investments, such as penny stocks or stocks of companies with little or no profit. Penny stocks are small companies whose shares trade at very low prices. They are usually not listed on major exchanges and often do not provide financial information, giving investors little transparency and making them risky investments.

In recent years, many companies have used cheap debt to fund their operations, hoping for revenue growth and worrying about profits later. However, with the economy slowing, revenue growth is harder to come by, and with higher interest rates, investors want to see more profits today. These companies could be hit by both an economic recession and a lower valuation due to higher interest rates.

Many believe that cryptocurrencies like Bitcoin are also speculative. Cryptocurrencies have no intrinsic value because they do not generate anything for their owners, such as dividends or profits. Cryptocurrencies experience volatile price fluctuations and can record significant losses during recessions.

How to Keep Your Investments in Recession

Recessions don’t mean you should get rid of all your investments. Falling stocks can mean opportunities for investors to buy valuable long-term investments at discounted prices. Differentiating between what you should let go of and what you should invest in is a crucial first step.

“Overall, investors should consider balancing capital preservation in their portfolios in the short term with staying invested for longer opportunities. In this environment, how you gain exposure is paramount. We recommend that investors focus on higher-quality investments and avoid more speculative areas of the market,” says Sid Vaidya, chief U.S. investment strategist at TD Wealth.

That means focusing on companies with resilient balance sheets, high-quality fixed income instruments such as Treasury bonds and mortgage-backed securities, and credit instruments such as investment-grade bonds, Vaidya added.

Treasury bonds and mortgage-backed securities are higher quality securities that offer steady income and stability.

Summary

It’s important to stay invested in a recession and not simply empty your positions into cash — but the quality of your investments is key. Avoiding highly leveraged companies, high-yield bonds, and speculative investments will be important during a recession to ensure your portfolio isn’t exposed to unnecessary risk. Instead, focus on high-quality government securities, investment-grade bonds, and companies with solid balance sheets.

—Georgina Tzanetos contributed to a previous version of this article

Editorial Disclaimer: All investors should conduct their own independent research into investment strategies before making an investment decision. In addition, investors should remember that past performance of investment products is not a guarantee of future price growth.