As the old adage goes, “The only constant in life is change.” This holds true for the financial markets as well. Cycles of economic growth and recession are a natural part of any economy, and the savvy investor (whether that’s the Rich Guy or the asset manager the Rich Guy is smart enough to hire) knows how to prepare for both scenarios.
Wealthy Americans, in particular, have unique challenges and opportunities when it comes to positioning their investments for a recession. It’s important that, on your journey toward Rich Guy status, you take the steps to protect your assets like it’s a much larger account. Let’s take a closer look at some of the common strategies used by wealthy investors to navigate economic downturns.
Diversification
Diversification is a tried and true strategy for investors of all stripes, but it is especially important during times of economic uncertainty. Rich Guys typically have a broad range of investments, including stocks, bonds, real estate, and alternative assets such as commodities or private equity.
The idea behind diversification is that not all investments will perform the same way at the same time. During a recession, some sectors of the economy may suffer while others remain relatively stable or even thrive. By diversifying across different asset classes and industries, investors can minimize their exposure to any single risk.
Defensive Stocks
During a recession, some companies may fare better than others. For example, consumer staples companies that sell everyday essentials like food, toiletries, and household goods tend to be less affected by economic downturns than companies in more discretionary sectors like luxury goods or travel.
Wealthy investors may choose to overweight their portfolios with defensive stocks, which are less likely to decline in value during a recession. However, it’s important to remember that there are no guarantees in the stock market, and even defensive stocks may decline in value during a severe recession.
Alternative Assets
Rich Guys may also choose to allocate a portion of their portfolios to alternative assets, which are investments that fall outside of traditional stocks and bonds. Alternative assets may include things like real estate, private equity, or commodities.
The idea behind alternative assets is that they may provide diversification benefits and potentially higher returns than traditional assets. For example, real estate may be less correlated with the stock market, and private equity may offer the potential for high returns through investments in private companies.
However, alternative assets also come with their own set of risks and challenges. Real estate investing requires significant capital and may be subject to fluctuations in the housing market, while private equity investing may require extensive due diligence and a long-term investment horizon.
Cash and Cash Equivalents
Another strategy that Rich Guy investors may use to prepare for a recession is to hold a significant amount of cash or cash equivalents, such as short-term Treasury bills or money market funds.
Cash and cash equivalents provide a “safe haven” for investors during times of uncertainty. In the event of a recession, investors may need to sell their other assets to raise cash, and having a significant cash position can provide a cushion against market volatility.
However, holding too much cash can also be a drag on returns, especially in a low-interest-rate environment where cash may earn little or no return.
Hedging Strategies
This one is key: Rich Guys may also choose to use hedging strategies to protect their portfolios during a recession. Hedging is a way to offset potential losses in one investment with gains in another investment. Please note that these are not investment recommendations in any way for your particular situation. Most hedging strategies are complicated and involve additional cost and risk that aren’t suitable to every investor.
One common hedging strategy is to purchase put options, which give the holder the right to sell a particular stock or index at a specified price within a certain time frame. If the stock or index declines in value, the put option can be exercised, providing a payoff that offsets some or all of the losses in the underlying investment.
Short selling is another popular hedging strategy used by Rich Guys to offset potential losses in their portfolios during a market downturn. This strategy involves borrowing shares of stock from a broker and selling them in the open market, with the intention of buying back those shares at a lower price in the future.
The investor who uses this strategy expects the price of the stock to decrease, which would enable them to purchase the shares at a lower price than what they sold them for, earning a profit. This profit can then be used to offset the losses incurred in other investments.
For example, if an investor is holding shares of Company A in their portfolio and expects a market downturn, they may decide to borrow and sell shares of Company A through short selling. If the price of Company A’s shares does fall as expected, the investor can repurchase the shares at a lower price, return them to the broker, and make a profit on the difference between the selling and buying prices.
However, it is important to note that short selling carries significant risks. If the price of the stock increases instead of decreasing, the investor would have to buy back the shares at a higher price than what they sold them for, resulting in a loss. Additionally, the broker can recall the shares at any time, forcing the investor to buy them back at potentially unfavorable prices.
Overall, short selling can be an effective hedging strategy when used correctly, but it requires careful consideration and expertise in order to minimize risks and maximize potential profits.
Think Bigger
As we say here often, in order to have what Rich Guys have, you need first to think the way they think, and then do what they do. We do this because reinventing the wheel, when so much has been learned (and willing shared) by those who have achieved before you, is folly and more importantly, a waste of time and life energy.
You can, of course, learn to manage your own money and with time, might become proficient at it. Or, you can do what most Rich Guys do – outsource those daily management decisions to a fiduciary money manager. If you’re in need of someone to manage your account, or even help you start one, here’s a great place to start.