A slowdown of the economy can simply be defined as a fall in economic activities which can last for months or years. If the economy slows down a lot, then it is classified as a recession.
A recession is associated with a decline in retails sales, skyrocketing rate of unemployment, fall in the value of stocks, falling income and very low manufacturing performance.
The UK last experienced a recession as a result of the COVID-19 pandemic which made the country’s GDP shrink by 20.4% in April 2020
Going by the report of the Office of National Statistics released on May 18, 2022, the inflation rate increased to 7.8% in the 12 months to April 2022, from 6.2% recorded in in March.
Also this year, the Bank of England raised Interest rates from 0.75% to 1% and when this is coupled with high inflation and the supply chain disruptions caused by the Russia- Ukraine war, the economy, may be near stagflation and even recession.
Here are the things you can consider doing in case the case the economic crisis escalates to a full scale recession.
You should have Emergency Funds
In the face of the looming economic recession, you need to create a special emergency fund account that would always meet your most essential needs. It will also provide you with funds to live on in case of a business failure or job loss.
Storing cash in Bank savings accounts won’t pay much interest so you could put it in Certificate of Deposit (CD) accounts.
Money held in CD accounts usually have a contract period of one month and above during which you leave the funds untouched and you earn interest. You can also liquidate the CD at any time although terms and conditions will apply.
Maintaining an emergency fund is crucial as it prevents you from having to sell your investments when there’s an urgent need for money. Selling investments during a recession may mean you selling at a loss and this will be bad for your portfolio.
During a recession, selling may be bad for you but buying is good because you could snap up good stock at a discount.
You should Diversify
During recessions there is a decline in value of stock and there is usually an overreaction by investors to every single news even when unverified. In such times, you need to adopt a low risk posture by not investing too heavily in one asset class or sector and this is the logic behind diversification.
Consider the following assets if you want to diversify effectively:
1 . Diversify with ETFs
Debuting on the London Stock Exchange (LSE) in April 2000, Exchange Traded Funds (ETFs) pool investor resources together and invest them in a basket of securities. Some ETFs track an index like the FTSE 100.
Buying into an ETF that invests in a basket of stocks means you own shares of all those companies whose stocks are in the basket.
If the ETF tracks an index, you also own the stocks of companies that make up that index. ETFs are a very easy way of diversifying. Most ETFs are passively managed meaning they try to replicate and index’s performance not beat it.
In the words of Warren Buffet: ‘By periodically investing in an index fund, the know-nothing investors can actually outperform most investment professionals’ This is true because index funds (ETFs that track an index) focus on the best companies and if you are not very experienced you’d be better off with ETFs.
ETFs are good investing instruments because in the UK they don’t attract stamp duty and they have one of the cheapest annual charges amongst collective investment schemes available in the UK. There are more than 1200 ETFs available on the LSE. Some popular ones are:
- iShares Core FTSE 100 UCITS ETF GBP: it invests in shares of the 100 companies that make up the FTSE 100 index
- Vanguard S&P 500 ETF UCITS ETF : invests in shares of the 500 companies making up the S&P 500 index
2 . Diversify with Mutual Funds
Mutual funds are professionally managed funds that take money from investors and invests in various assets and they can also track an index like the FTSE 100.
Most mutual funds are actively managed funds meaning they try to outperform an index. They are similar to ETFs but one major difference is that they don’t trade on the stock exchange.
Mutual funds give you a more personalized investing experience but may charge more fees than ETFs. Examples of mutual funds in the UK are:
- OHCM UK Equity Income Fund: it invests in shares of UK companies that pay dividend
- Fidelity UK smaller Companies: it invests in the shares of small Cap Uk companies
- Vanguard sustainable life 60-70% Equity Fund
The price of a mutual is called its Net Asset Value (NAV). It is gotten by subtracting the funds assets from its liabilities then dividing the result by the number of outstanding shares. Unlike ETFs where the demand and supply determines its price, a mutual fund’s NAV is calculated at the end of every trading day
3. Diversify with REITs
A REIT is a company engaging in income generating property rental business. REITs are listed on the London Stock Exchange and their share price determined by market forces of demand and supply.
When you buy shares of a REIT you are paid dividends periodically as law mandates them to pay 90% of their taxable income as dividends yearly. You can always sell your holding anytime and quit as there is sufficient liquidity in the REIT market.
REITs in UK are exempted from corporation tax on rental income and gains on sales of investment properties. Due to these features, REITs have been attractive to investors since their debut in the UK in 2007.
Some examples of REITs available for UK investors are:
- AEW UK REIT PLC (Ordinary share)
- BMO Real Estate Investments (Ordinary share)
- Supermarket Income REIT PLC (Ordinary share)
Invest in Government Bonds (a.k.a. Gilts)
Governments auction bonds when they want to borrow funds from the public for capital projects. Bonds are a major source of financing for many Governments and an alternative to shylock Bank loans. When you buy a bond you earn interest semi-annually or annually and upon maturity your principal is refunded to you
Every UK Bond comes with a price tag, a maturity date and of course an interest or coupon rate. For example, 3% Treasury Gilt 2030 can be interpreted to mean you will earn an interest of 3% annually till the year 2030.
UK bonds are very safe as the UK government has never failed to keep its end of the bargain. But these are not good hedge against the rising inflation.
You should consider defensive Stocks
Defensive stocks are those of companies that produce necessities/goods people will always need even in a recession. These stocks are regarded as inflation proof.
Although, these “defensive stocks,” are not usually attractive when there is economic stability, during a recession, you should consider them. This is because everyone buys their products and some are even addicted to them. Examples of defensive stocks are Unilever, Diageo and British American Tobacco.
What you should not do during recession
Do not speculate
During a recession you may be tempted to short the market by speculating on downward price movement of stock.
Popular speculative derivatives like Contract for Difference (CFD) that allow you benefit from the falling prices of stocks without owning them are risky.
This is because CFDs use margin borrowing to enable leverage where you are exposed to more stock than you could have afforded if you had not borrowed.
Leverage is a two edged sword and if your speculation is wrong and the stock prices rise instead of fall, you could lose all your capital and this would be disastrous in a recession.
About 65 to 82% of retail investors lose money trading CFDs as can be seen on the websites of regulated brokers, as per this comparison of forex brokers in the UK. Betting on falling prices exposes you to unlimited losses if the prices rise and speculation during a recession had better be left to professional hedge fund managers.
During a recession defensive investing is ideal and you should not take unnecessary risk. Money lost in a recession may be hard to recoup.
You may be under intensive pressure to sell off your stock and quit your position until the market storm is over. This may be a catastrophic decision because a recession is temporal. Historically, Bull runs have always followed recessions and quitting may knock you out of future opportunities as the economy starts to show signs of a recovery.
We will get out
Economic slowdown doesn’t last forever. So, it is not the end of life if your investment is caught in the web of the meltdown.
Don’t engage yourself in speculative trading during this period. Stick to safe haven assets like Fixed Income portfolio and defensive stock.