Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Recession-Proof

What it is:

A recession-proof investment does well or at least remains stable during economic contractions.

How it works (Example):

Defensive stocks are the most famous kind of recession-proof investments, because they generally are able to weather economic dips. It is important to note that they -- and most recession-proof investments -- tend to ignore economic upswings, though.

Recession-proof investments are mathematically identifiable because they generally have betas below one, meaning that their statistical volatility does not coordinate strongly with the overall volatility of the market. Intuitively, they usually can be found in industries that produce necessary and often relatively cheap products that consumers don't feel they can go without even when times are tight (think utility, food, and oil industries). Because consumers' frequent purchases of these products represent a relatively small portion of most consumers’ annual income, demand tends to be fairly stable year-in and year-out.

Why it Matters:

Thanks to the stability of demand for their products, sales and earnings growth in recession-proof industries tend to remain constant in good times and bad. With this in mind, safe, recession-proof stocks (particularly those that exhibit steady, stable growth from core brands and a history of cutting costs and holding profit margins steady) can provide investors with a great way to hedge their overall portfolio risk. However, investors should not expect eye-popping growth from recession-proof investments; instead, they should expect to pay for the stability and quality of non-cyclical earnings that these investments offer.

As with any investment strategy tied to the business cycle, however, active investors attracted to recession-proof securities are often faced with the arduous task of trying to time the market -- that is, to predict when things are starting to head south so they can buy recession-proof securities at the optimal time, and then predict when things will turn around so they can sell at the optimal time and invest in higher-beta securities. Although this approach can optimize returns, many investors hastily pass over recession-proof securities in favor of more aggressive names during economic expansions and thus introduce undue risk to their portfolios.