All investing involves a degree of risk. However, recessions can create the potential for even bigger problems for the typical investor. And the sad reality is that recessions can and do happen regularly.
As a result, "recession-proofing" your stock portfolio is a top priority for many low-risk investors. They want solid companies that stand up in any environment so their nest egg is protected against serious economic downturns.
So what are the best kinds of stocks to buy for a recession, and how can these stocks fit into a broader investment portfolio?
What is a recession?
A common definition of a recession is two consecutive quarters where the U.S. economy has been shrinking, as measured by the growth rate for gross domestic product (GDP).
This can also apply to other nations, the global economy, or even other financial metrics beyond GDP. For instance, some stock market analysts will refer to an "earnings recession" where the average growth rate of the largest stocks has been negative for two quarters in a row. The most recent earnings recession occurred in late 2022 through mid-2023.
Generally, a recession means a sustained decline rather than a short-term disruption or positive rates of growth.
Recessions can happen for many reasons – a global financial crisis like 2008, geopolitical unrest like the wars in Ukraine or Gaza or even a global pandemic. And while economists can sometimes detect waning momentum, unexpected events are often to blame. That can catch even the smartest businesses, consumers and investors by surprise.
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The best kinds of stocks to buy for a recession
Whether you're worried about troubles in the short term or you simply want a resilient portfolio that stands up to the unexpected, your approach to seeking out the best stocks to buy for either situation should be similar.
Here's what to look when researching the best kinds of stocks to buy for a recession:
Avoid cyclical stocks: The economy tends to run in cycles, and some companies do very well when business is booming but suffer mightily when recession strikes. These are called "cyclical stocks” because they're very sensitive to trends in business or consumer spending. Think hotels that depend on strong travel spending, automakers selling high-priced cars or retailers who depend on Americans taking frequent trips to the mall.
Focus on defensive sectors: While more defensive sectors may not have as much upside when things are booming, they tend to be more stable when things get tough. Examples of defensive stocks include electric utilities or companies selling consumer staples such as soap and packaged foods. You're not going to stop turning on the lights, showering or eating pasta just because the economy is a bit rough, after all. Defensive stocks depend on strong baseline demand rather than the economic cycle.
Go a bit bigger: It's universally true that the larger companies on Wall Street are more stable than the smaller ones. They have cash reserves to fall back on, as well as big brand names and rich histories that can better withstand short-term disruptions. Although smaller companies can move more quickly to take advantage of new opportunities, they can be the first to suffer when times get tough. Going bigger helps reduce your risk profile.
Prioritize dividends: Large companies with stable profits often share some of the wealth with investors via regular dividends. This flow of profits back to shareholders sweetens the returns, which is nice, but it also proves a level of reliability in the company's operations. Cutting dividends is a huge black eye for a stock, so if a company delivers regular payouts – or, in the best-case scenario, are stocks known for dependable dividend growth – that's a sign of operational consistency that should give you confidence.
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How to prepare your portfolio for a recession
The desire to be defensive and protect your hard-earned cash is natural. But it's important to note that simply going for low-risk investing may leave some long-term profits on the table.
If you completely ignore growth stocks like smaller start-ups or aggressive tech disruptors, you may be disappointed when you don't share in the good times as often as your peers. Furthermore, even defensive stocks can stumble – so there's no guarantee your money is 100% protected either way.
A balanced approach is almost always the best course of action, then. That includes the best kinds of stocks to buy for a recession, as well as other instruments that will provide consistent and diversified returns in any market.
Your personal risk tolerance informs how much or how little of each investment you focus on. But the bottom line is that going "all in" on recession-proof stocks may be just as risky as putting every penny behind small and risky growth stocks. Looking at the whole array of options out there is usually the best course of action for the typical investor.
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