Recessions often raise concerns about another Great Depression. 

 

Of course, you can still protect your wealth and make money during market corrections. One of the ways to preserve your financial well-being is to invest in recession-proof assets.

 

These assets perform the best when the market is down, and also when people expect deflation or a bullish market in the near future.

 

In this article, I will discuss how to profit and preserve your wealth during market corrections while anticipating a bull market.

 

By investing in and researching the different types of securities, I noticed which ones performed best during more difficult economic times.

 

1. Defensive Stocks

 

Stocks tend to perform at their best when held for 5 years or more as they outpace inflation over time.

 

Stocks average 10% on annual returns. So, if the average annual inflation rate is 3%, stocks will produce 7% on real returns (10% return minus 3% inflation).

 

Stocks, especially those in the S&P 500, tend to return 10% a year while inflation averages 3%. In this case, real returns are at 7%.

 

During a recession, the best stocks to buy are the defensive ones. They “defend” themselves well against economic opposition, hence their name. These stocks include consumer staples, utilities, energy, and healthcare companies.

 

McDonald’s and Wal-Mart are examples of good consumer staples stocks. These multinational companies are both well-known in the United States and around the world. 

 

Even during inflation, these two companies offer foods at relatively low prices compared to their competitors, which is why many people shop at these places. Also, both companies have hundreds of stores nationwide and worldwide. People will mostly buy things they need, such as food, when prices go up. 

 

Utilities stocks and energy companies are great investment choices during recession because we all need electricity for our lights, TV, internet, etc. I would say that many of us could not live without these things. Also, we use transportation which requires gas and oil in addition to electric batteries. 

 

You may want to consider investing in healthcare companies because they often perform well in volatile markets. Everyone visits the doctor’s office and buys medicine.

 

These four sectors usually outperform other stocks when the market is down. So, it’ll be better to invest more money in them when there’s an economic slowdown.

 

When you invest in defensive stocks, add blue-chip stocks, like Microsoft, Amazon, or Walmart, to your portfolio because they provide stability. These large companies have a history of revenue growth and consistent dividend payments. It’s even better if these companies are from those four sectors mentioned.

 

2. Corporate Bonds

 

Corporate bonds are good investments during this stretch. Their prices do fall along with their corresponding stocks. Not only is this period a good time to purchase these bonds, but these securities have a fixed dollar amount you collect at the maturity date known as the face value. You’ll profit from this investment as long as you buy the bond at a discount, below its face value. If the price rises, you can also sell the security on the secondary market for a gain.

 

Bonds’ prices tend to be less volatile than stocks, even during the Bear Market. If you compare your stock portfolio to its bond counterpart, you’ll see that the bond holdings will probably lose less value than those in equities. In some instances, the bond portfolio has produced returns during market corrections even though the returns are smaller. 

 

When a bull market occurs, bond prices will appreciate since the Fed has already lowered the market rate. A bond’s market value is subject to interest rate risk. Bond prices are likely to fall since the benchmark rate is higher amid a recession. 

 

If the Fed’s rate is higher than the bond’s coupon rate, the bond is less valuable because investors are likely to buy bonds whose interest rates match the market rate. During a rising market rate, the newly issued bonds will have a higher coupon rate than the bonds in the secondary market.

 

When market interest rates drop, bonds become more valuable. The newer issues will have a lower coupon rate while the older, existing bonds will have a higher interest rate, making them more valuable.

 

We saw this during the COVID recession when the Fed Funds rate fell all the way to 0.25%. In the secondary market, bonds were offered at a premium, or above the par value, because the market rate hit an all-time low around that time and also during the 2008 crisis.  

 

A good indicator that the Fed will lower the rate is when it lends lots of money to Uncle Sam, or buys a lot of Treasury Securities. Consumers will borrow and spend more at lower rates, boosting the economy. Also, corporations will happily issue bonds at lower interest rates.

 

So, investors will have to look into the secondary market to find bonds with higher interest rates. The problem is that these bonds will be more costly because their prices are at a premium, and their coupon rates will be higher than the market rate. This is another good reason to hold onto these assets during economic turmoil.

 

The key is to buy them from very solvent companies, such as blue-chip businesses. It is smarter to buy bonds with the highest credit ratings, which are AAA and AA (Aaa and Aa from Moody’s).

 

If you buy any bonds, the best ones to always purchase are those with sinking fund provisions. 

 

Why is that important?

 

The sinking fund is money the company puts away periodically while letting the interest accumulate on the balance, so the money grows exponentially to pay off the bond’s principal upon redemption.

 

This means that these companies have sinking funds established exclusively to pay off the bonds’ debt.

 

You do have to consider their call provisions, which state when the issuer decides to redeem the security before the maturity date. In most cases, the issuer can only redeem the bond within a specified period of time. Many of these bonds may have a deferment period during which the issuer is not allowed to redeem this debt instrument within that time frame. 

 

If the issuer calls the bond away, you will lose out on more interest income, but you will receive the face value or a premium amount.

 

As long as you purchase the bond at a discount, you’ll profit from this trade, especially if you buy and hold highly rated bonds from reputable companies.

 

3. Municipal Bonds

 

Muni bonds are another alternative during the recession.

 

These bonds provide federally tax-free interest income. This is something to consider when the inflation rate rises because the inflation rate affects the after-tax return.

 

Munis can be attractive investments since you never pay federal taxes on the interest, and you can even be exempt from state and local taxes if you buy and hold the bonds of your state of residency.

 

The main concern is whether you can get a real return, depending on the coupon rate and the inflation rate.

 

During the early stages of a rising inflation rate, cities and states see tax revenue growth since they’re collecting more tax dollars as the prices of items go up.

 

This benefits them if inflation is short-lived. 

 

If the inflation lasts too long, both the city and the state may start experiencing a decline in tax revenue since consumer spending will decrease as the economy slows down.

 

As interest rates rise, muni bonds’ value will also decrease if their coupon rates are lower than the market rate. Any of those with interest rates higher than the benchmark will be more valuable. Hence, their price will be higher even if they are offered above their face value.

 

Of course, these bonds’ prices will rise if interest rates fall. The economy will also speed up with falling rates, which means the city and state will collect more and more tax dollars. If both entities are receiving lots of tax money, they’re likely to pay off debt.

 

Like corporate bonds, you may want to buy and hold muni bonds with a high investment grade of AAA or  AA since these highly rated issues are less likely to default.

 

Just like corporate bonds, muni bonds can also be callable.

 

4. Treasury STRIPS

 

What are these?

 

First, let’s discuss what STRIPS are. 

 

STRIPS is an acronym for Separate Trading for Registered Interest and Principal of Securities.

 

Now, we know what this stands for, but what does that all mean?

 

Well, these types of bonds are somewhat unique. With a typical bond, you receive periodic interest up to maturity along with the face value. All of this comes from each bond issue.

 

STRIPS is a form of coupon stripping for Treasury security. You’re not collecting the interest until maturity, but each periodic interest becomes a separate issue instead of a semiannual dollar amount. 

 

So, you would get multiple issues per STRIPS bond issue. There’ll be multiple issues for all semiannual interest periods and an issue for the principal, or face value.

 

If you buy a STRIPS bond with a 20 year maturity date, you would have 40 semiannual interest periods. That means you would own 40 total issues for the interest alone and one issue for the principal. In all, you’re getting 41 issues per STRIPS issue! Yes, that sounds crazy! 

 

If you buy Treasury STRIPS, each separate issue will have a $100 par value.

 

Let’s say you buy a STRIPS with a $100,000 face value and a 3% coupon rate. Now, you receive $3,000 each year. 

 

Instead of receiving interest in cash every 6 months, you’re receiving interest in the form of separate issues in addition to the issues of the principal. You would receive the cash at maturity or if you sell them in the secondary market. Yes, that’s correct. You can sell the interest and principal as you would with any bond issue. 

 

Treasury STRIPS are great investment vehicles to own during inflation if you hold them to maturity. They will not be as valuable in the secondary market since the Fed has likely raised the market rate during these periods to bring inflation down. 

 

However, these types of bonds tend to have lower yields, just like other Treasury Securities. This can be a concern if inflation continues to rise because the yields may not keep up with the inflation rate.

 

You still have to pay taxes on interest every year even though you do not collect the interest until redemption.

 

If you hold the Treasury STRIPS, you only pay federal tax on the interest. You never pay state and local taxes on Treasury Securities.

 

5. Bump-up CDs

 

Your traditional certificates of deposits (CDs) may not be good investment vehicles even during the period of rising interest rates because the high inflation rate will eat away at your returns.

 

So, we need to find cash alternatives that can protect your money during inflation.

 

This is where Bump-up CDs come in.

 

These CDs have a variable interest rate. 

 

These CDs’ interest rates only rise once if there’s a rise in the market rate, unlike a Floating Rate Note (FRN) whose rates change multiple times.

 

You’ll maintain that increased rate until maturity.

 

The good news is that the interest rate will never be below the original interest rate of this product.

 

If you buy a CD with a 5% rate, and the market rate drops to 4%, the CD will remain at 5%.

 

They are not the most ideal of all inflation-protected assets because of the one time rise in their interest rate. 

 

But if you buy at the right time when the market rate rises for the last time during a stretch, it can be a good place to park your cash since you’ll lock in a high rate.

 

If the market rate rises from 5% to 5.5% when you purchase a 5% bump-up CD, your CD’s rate will also rise to 5.5%. 

 

However, the interest rate will remain at 5.5% regardless of whether the market rate goes up or down again. This is a concern if there are no signs of deflation, let alone falling market rates and a bull market.

 

However, another benefit to consider is that this product is federally insured under the Federal Deposit Insurance Corporation (FDIC) just like many types of CDs. Just keep in mind that the FDIC has a maximum limit of the account’s value (usually $250,000). 

 

If you deposited $249,000 and earned $3,000 worth of interest, you would have $252,000 in the account. As soon as your bank becomes insolvent and goes bankrupt, the FDIC would only pay back $250,000 instead of $252,000. 

 

So, you would lose out on the other $2,000. It’s better to deposit less than the maximum limit just in case that institution goes bankrupt, so you can get back the full amount of that account’s value.

 

As with any CD, you’ll pay a penalty if you withdraw money before maturity.

 

6. Variable-rate CDs

 

Variable-rate CDs are like CDs that resemble FRNs.

 

The interest rate is not fixed, and it will match the benchmark rates.

 

These financial products will still have a maturity date and a penalty for withdrawing the money early.

 

These CDs are wonderful tools to use when you want to park your cash somewhere while taking advantage of rising rates.

 

They are great to invest in when you anticipate the market rate going up before the CD matures.

 

The problem is that very few institutions offer these products. You would have to do thorough research to see which companies offer them if you are interested.

 

This investment can work against you if the inflation rate is higher than the interest rate offered. If anything, this security works best when you expect rising market rates and a drop in the inflation rate. This is the case with any investment you make. Therefore, you weigh the real return against the real loss.

 

There is a real return when the annual return is higher than the inflation rate, and vice versa with real loss. If the interest rate is 5% and inflation is at 4%, you have a 1% real return. In this case, it would be worth buying the variable-rate certificate.

 

But if the interest rate is 3%, and inflation is at 4%, that’s a -1% real loss. It would be a bad investment since you’re just losing out on parking your cash in this scenario.

 

Like the Bump-up CD, your variable-rate CD is also FDIC-insured. So you will not lose all of your money if the financial company becomes insolvent.

 

CDs are risk-averse which means they carry a smaller risk than other investments, but the returns are relatively low.

 

I know how anxious you can get during bad times in the economy. You should not worry too much, though! 

 

As we learned, there are ways to survive financially in a downturn. Just keep your head up and wisely spend and invest your money. 

 

You will be proud of yourself for taking the necessary steps to protect all of your money! 

If you want to know more ways to make money in a recession, click here.

 

Click here if you want to know the best ways to make money during inflation.