Investing during a recession can be a daunting proposition but investors should be wary of pulling their money out of the market at the first sign of economic distress, according to Charles Stanley’s Rob Morgan. 
In last week’s Autumn Statement, chancellor Jeremy Hunt confirmed that the UK economy is now in recession – one that is expected to last for more than a year.
Morgan, chief investment analyst at Charles Stanley, said: “Though current news is full of worry, economic downturns do not last forever. If history is a guide, a good way to avoid losses in a recession is to take a long-term approach and ignore the noise.”
Below, he offers five rules for long-term investors building their portfolio during a recession.
1. Diversify
Morgan highlighted diversification – or making sure that a portfolio includes different kinds of shares and other financial assets so they are not overly reliant on any one investment performing well – as being the first thing to consider.
“As investment great Sir John Templeton put it, ‘The only investors that don’t need to diversify are those that are right 100% of the time’,” he said.
“Nobody is, so the sensible thing to do is to prepare for different outcomes and spread your money around so you are not reliant on a single company or type of business.”
Investors who ignore this rule and focus too much on one type of company or sector could find themselves in for a rocky ride if their favoured assets are the ones at the centre of the market’s storm and their portfolio is disproportionately hit.
2. Avoid market timing
There is a tendency for investors to spent a lot of time deciding exactly when to invest – asking if the market has fallen ‘enough’ before buying or trying to predict the peak before selling – but Morgan wrote this approach off as “a losing battle”.
Some investors may feel anxious about putting money into the market during a recession but, while this can cause volatility, there is no way of knowing exactly when the low point will arrive or if it has already passed. Getting this wrong could mean investors miss out on the early gains of a recovery.
“We can conclude from studying stock market history that investing at a market bottom during a recession tends to lead to excellent returns,” Morgan said.
“Some of the strongest returns can occur immediately afterwards, which makes things all the more frustrating for the market timers. That’s one reason to keep invested, the other is that exiting the market interrupts the flow of dividends, interest and other income, which can make up a substantial portion of returns over time.”
3. Own ‘inevitables’
Morgan argued that a focus on quality companies can be especially important during a recession as resilient earnings and a strong balance sheet become universally desirable.
“Certain businesses have an ‘economic moat’ around them. For instance, offering a unique proposition, dominating market share through a superior product or unparalleled channels of distribution. In these circumstances, it is hard for newcomers to penetrate the market, so the strong are likely to get stronger,” he explained.
“Some sectors are also naturally more resilient to economic downturns, for instance, food and beverages, healthcare and utilities owing to their greater share of essential rather than discretionary spending.”
This means that good-quality businesses have time on their side during a recession as their competition is thinned out and they are left in a healthier position.
4. Avoid vulnerable businesses
Poor-quality companies, on the other hand, are much more dependent on a recession ending quickly if they are to survive. Morgan therefore recommended avoiding these stocks when the economy is going south.
“The worst performers during a recession are usually businesses that have a lot of debt, are tied closely with the economic cycle – perhaps in terms of consumer or industry spending – or are otherwise speculative and reliant on securing further funding from increasingly wary investors,” he said.
“Companies that fall into any of these categories have the potential to go bankrupt, leaving little or nothing for shareholders.”
That said, he pointed out that companies that come close to going under but manage to survive a recession can make highly profitable recovery stories, although he caveated that it’s very risky backing low-quality and distressed companies.
5. Just keep going
Because of the difficulty in calling the tops and bottoms of markets, it often becomes less stressful if investors just drip-feed their money in.
“Provided you can afford to, keeping up the investing habit through difficult times makes sense. By investing monthly, for instance, an investor ends up buying more shares or units when prices become cheaper and fewer when they become more expensive,” Morgan finished.
“This can be a great way to invest because if you keep buying the market falls you could, over time, turn volatility to your advantage.”