An economic recession sends ripple effects across the economy. Although everyone feels the effects, most can only wait for sunnier economic times to appear. Knowing how long a recession can last can help you weather the storm. A financial advisor can guide you in making smart investment moves for your portfolio in a recession.
What Is a Recession?
A recession is a serious economic downturn that lasts for more than a few months. Generally, an economic downturn isn’t considered a recession until the economy has seen negative growth for at least two quarters. Economic growth is measured by gross domestic product (GDP).
You might see a rising unemployment rate or falling stock prices during a recession. Investors have fewer funds on hand to invest and often lack the necessary confidence to invest in the market.
One important indicator that acts as a warning sign for a recession includes an inverted yield curve. In this case, the long-term government bond yield is lower than the short-term government bond yield. This inversion indicates a lack of faith in the economic times. Since 1970, an inverted yield curve has happened before every U.S. recession.
A few other indicators include closing businesses and stock market contractions.
How Long Do Recessions Last?
According to the Congressional Research Service (CRS), the average length of recessions between World War II and 2019 has been approximately 11 months.
But the exact length of a recession is difficult to predict. In general, a recession lasts anywhere from six to 18 months.
For example, the Great Recession that started in December 2007 lasted 18 months. But the recession prompted by the pandemic in 2020 only lasted two months. When a recession is on the horizon, it’s impossible to know how long it will last.
When Does a Recession Become a Depression?
The length of a recession varies. But where’s the line between a recession and a depression?
In general, a depression is an economic downturn that lasts longer than expected or has extremely severe consequences. But there’s not a technical definition that distinguishes a depression from a recession.
For example, the Great Depression and Great Recession both made names for themselves. But the negative impacts of the Great Depression were much larger than the impacts of the Great Recession. That’s because the Great Depression lasted 10 years! That’s significantly longer than any recession on the books.
How to Prepare for a Recession
In an extended downturn, almost every household feels the pinch of a tighter budget. Financial security can be lost in the wake of unemployment spikes and plummeting retirement savings. But the reality is that recessions are part of the business cycle. Instead of hoping one never comes, preparing for a recession is better. Here are four common strategies to prepare for a recession:
- Have an emergency fund. Rising unemployment is a hallmark of most recessions. If possible, build an emergency fund to cushion the financial fallout in case of a layoff. Most experts recommend saving between three to twelve months of expenses. But the right amount varies based on your risk tolerance and income stability.
- Consider your risk tolerance. The right investment portfolio carefully considers your risk tolerance. Since heavy losses are likely during a recession, you need to be able to stay the course.
- Invest in alternative assets. If you don’t want to have all of your eggs in the stock market, then look at other options. Real estate and precious metals are a few potential investment options to consider.
- Don’t panic sell. If you have a portfolio of assets, don’t panic. Although tempting to sell off your assets at the beginning of a recession, it’s often better to stay the course. Jumping in and out of the market in an attempt to time the market often leads to lower returns over the long term.
How to Rebalance Your Portfolio During a Recession
During a recession, investors may adjust their portfolios to focus on stability and lower risk. A balanced portfolio could include a mix of defensive stocks, bonds and other assets that tend to perform well in economic downturns.
For example, an investor with a $100,000 portfolio might allocate 40% ($40,000) to high-quality government and corporate bonds, which provide steady income and lower volatility. Another 30% ($30,000) could be invested in defensive stocks, such as healthcare, utilities and consumer staples, which tend to hold their value during economic slowdowns.
The remaining 30% might be split between dividend-paying stocks ($15,000) for reliable income and cash or money market funds ($15,000) for flexibility and security. This type of portfolio could help you protect against market declines while still allowing for potential growth when the economy recovers.
Bottom Line
If you are investing with a recession on the horizon, don’t panic. The good news is that recessions are part of a normal economic cycle. It’s likely that the economy will pull out of a recession within a year. But staying financially comfortable during tumultuous times can be a challenge. A financial advisor can help you navigate a changing economy with your long-term goals in mind.
Investment Planning Tips
- A financial advisor can help you make smart investment moves for your portfolio. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A recession can test your risk tolerance limits. Determine the appropriate asset allocation strategy for your risk tolerance before a recession hits. Take a look at our free asset allocation calculator to consider optimal portfolio strategies.
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