In 2007, I learned firsthand what the word “recession” means. My business was booming, clients were coming to me left and right. My profit margins were great, and everything looked awesome…and then one day, it all disappeared.

Literally overnight! One day I had more clients than I could handle. The next, everyone was asking for their money back, canceling orders, and putting jobs on hold. People were scared, nobody knew what was going on. 

From my perspective, my clients just disappeared. From their perspective, the banks stopped giving out loans. From my parents’ perspective, their mortgage payment just tripled. It was the great recession. Of course, that isn’t what we called it. We called it “Monday.”

Economies are cyclical in nature. There are times when everything is good, and people buy, invest in their future, and then there are times when jobs disappear, belts tighten, and people make do with what they have.

We can’t predict when one economic cycle will end and another will begin. Technically, a recession in the US is only called by the “National Bureau of Economic Research.” They never call it prematurely, and they never call it early. By time they call it, we are long into the next economic cycle.

As an investor, waiting for the experts to make the next “call” is a surefire recipe for disaster!

As investors, we need to have our eye on the future. We need to be prepared for all possibilities and constantly read the economic tea leaves.

Will China’s economy grow, will the middle east go to war, will Russia invade its neighbors? All these questions will affect what asset classes perform and which flounder.

As investors, we need a strategy that is adaptive to changing marketing conditions. We need a strategy that will allow us to sleep at night. In my book Living with Financial Anxiety, I talk about how to insulate ourselves from the emotional impacts of the market. When you have a plan that protects your basic needs and ensures you will always have a roof over your head, food on the table, and the ability to sleep at night, then and only then, can we invest with confidence and able to properly allocate our dollars to strategies that will profit in all market conditions.

Taking this as a pre-requisite, here are some general rules of thumb to help you build a solid portfolio that can perform well during bull markets while offering a cushion when volatility strikes.

•  Have an investment policy statement in place. According to DALBAR’s annual Quantitative Analysis of Investor Behavior report, the “average” investor consistently underperforms the market. The reason is that investors’ emotions work against them. They end up buying high and selling low.

An investment policy statement helps remove the emotion from investing. It lays out when to buy, when to sell, and how to manage your portfolio.

Of course, you want your Investment Policy to be based on evidence, not emotion.

•  Use actively managed exchange-traded funds (ETFs). Actively managed ETFs may invest in companies that are fundamentally sound rather than buying the entire market. While your positions might take a hit during a recession, at least stocks you hold via these ETFs can stand a better chance of making a quicker recovery, or even profiting during recessions.

•  Maintain a portion of your portfolio to investment-grade bonds. These high-quality fixed-income securities are less volatile than lower-rated junk bonds. Junk bonds can be just as volatile as stocks during bear markets. You want your bonds to provide safety.
  

•  Stress-test your portfolio. Here’s a good method to stress test your stocks. Take your top five or ten holdings, then research their returns during the dot-com crash in 2000-02 and the Great Recession from 2007-09. Those recessionary periods can give you a good sense of how they might perform during the next big correction. The August 2015-February 2016 period, and February 19, 2020-March 22, 2020, were great time periods as well.

• Track Your Correlations: be sure your positions are not highly correlated with each other. If you own stocks from the same sector, that is a significant risk. Also, adding international exposure or buying uncorrelated investments like commodities can serve as a hedge.
  

•  Monitor the trading volume of your positions. Poor liquidity or being unable to sell an asset at a competitive price, can be a hidden risk.

If you have a stock that is not traded regularly, when you go to sell, you may end up selling at a significant loss. If you do have thinly traded securities, consider using “limit orders” to help ensure you get a fair price on your “sell orders” or simply shift to more liquid securities.

•  Increase liquidity as your time horizon declines. In general, the closer you are to retirement, the more “safe” assets you want to own—like a short-term bond fund or an aggregate bond fund instead of stocks. There are plenty “rules of thumb” when it comes to what ratio to use. My recommendation, use a ratio that provides a volatility level you are comfortable with…this is where doing that historical return analysis helps. Another way to think about it, is as a hedge. What percentage of the market’s movement would you like to experience? 60%, 70%, etc..
  

•  Take advantage of structured products. This investment type is not available to retail investors, but your advisor might have access to them through institutional relationships. Essentially, a structured product allows you to swap the market’s upside for predetermined protection such as a high yield or a limit on the maximum downside of an investment.

Remember, all the investment strategies in the world won’t help if they keep you up at night. Make sure that whatever strategy you are using, it is designed for your confidence and peace of mind. To learn more, read my book Living with Financial Anxiety.