Special Report

How the Wealthy Protect Their Assets in Recessions

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Owning defensive dividend stocks

In case of a recession, investors need not divest all their stocks. Instead, they may opt for high-quality, defensive, dividend-paying stocks. Defensive stocks are stocks in companies that are generally less vulnerable to recessions and market downturns due to their less cyclical nature. Companies that operate in such fields as food, health care, utilities, and nondurable consumer goods (soap and toothpaste, for example) tend to have more stable earnings.

Though such stocks may decline with the market, they tend to outperform it in times of recession (and often underperform in growth periods). Defensive stocks therefore reduce a portfolio’s overall volatility. Moreover, defensive stocks often pay a dividend, which further protects investors during a recession and increases the portfolio’s returns. Dividends can also provide a hedge against inflation, as companies that regularly increase their dividends — such as so-called dividend aristocrats, which are S&P 500 companies that have increased their dividend payouts for 25 years or more — would likely continue to increase the dividend, providing some protection against inflation, especially when compared to other fixed-income instruments.

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Investing in hedge funds

For wealthier individual investors, who can afford the higher fees and risks of hedge funds, investing in such funds can help protect against losses typical during a recession. Hedge funds pool funds from investors and invest in different securities. Because they are less regulated than mutual funds they are free to use riskier strategies (such as short positions). Hedge funds are limited to wealthier and institutional investors, according to the SEC.

Hedge funds are designed to make money regardless of market conditions. While hedging is a strategy that attempts to reduce risk, the goal of most hedge funds is to maximize return on investment — often by using many highly risky investment strategies (including derivatives, leveraged investments, and more). In fact, because hedge funds are aggressively managed and make speculative investments, they can carry more risk than the overall market. Investing in hedge funds may be a good way for the wealthy to diversify their portfolios.

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Investing in private equity funds

Unlike hedge funds, which seek short-term returns, private equity funds look at the long-term, 10 years of more. Managed by private equity firms, these funds are investing their pooled money directly in companies, either by purchasing private companies or a controlling interest in publicly traded companies and actively helping to manage them, or by making minority investments in fast-growing companies or startups. Their aim is to better realize the potential of the purchased companies.

Like hedge funds, private equity funds are only accessible to accredited investors, such as pension funds and high-income and high-net-worth individuals. These funds frequently use debt to acquire financially distressed companies. In the previous recession, private equity funds showed resilience, and nowadays larger investors are already shifting funds to private equity.

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Gold has always been considered a safe haven investment. The precious metal was even used to back currencies for some time. The United States abandoned the so-called gold standard in 1971. As a physical asset, it is assumed that gold will always retain some of its value — unlike paper money — even in bad times. In a recessionary inflationary environment, where the U.S. dollar may lose its value, gold can preserve wealth and be used as a hedge against a declining dollar. In such times, gold is often also a good investment, in that it can appreciate in value. Holding gold also provides protection in case of political uncertainty.

There are many ways to invest in gold, beginning with jewelry and actual gold bars and coins for direct exposure and ending with gold ETFs and gold mining stocks. Buying gold bullion is one method for high-net-worth investors to more directly invest in the metal. Investing in gold helps diversify a portfolio, and some gold stocks also pay dividends.

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In the case of a recession, investors can be doubly hit from currency risk. First, the domestic currency — the U.S. dollar — can lose value. Second, investments in other currencies (such as the euro, the British pound, or the Mexican peso) or in assets held in other currencies (such as foreign stocks, bonds, or real estate), may be exposed to foreign-currency fluctuations.

While some hedging instruments are available to all investors, it is easier for the wealthy, who likely have professional money and portfolio managers, to hedge against these risks by buying or selling certain currency hedge funds or by directly applying such strategies.