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Markets are falling: here's how you can invest through a recession

Stock market trader
The risk of an economic recession can take its toll on stock markets but investors have several ways to navigate the ups and downs Credit: Spencer Platt/Getty Images North America

Markets are falling everywhere. British company share prices are down 3pc this week, with American stocks not far behind. Investors are starting to panic as signs point to another recession.

The latest fears stem from a bond market phenomenon known as “yield curve inversion” where the yield on the British and American governments’ 10-year bond falls below that on its two-year bond.

This inversion is typically a sign of a recession in the near future, as it means shorter-term interest rates must fall to balance out, which only takes place when economic activity slows.

Despite the market panic, investors must remain calm and avoid hasty reactions. This inversion does not predict an immediate recession and it can be up to 12 months down the line. A recession also does not necessarily mean stock markets will fall, and are not abnormal but a normal part of economics and investing.

Given how far markets have risen since 2009 – British stocks are up 90pc and American ones up 227pc – a downturn in both the economy and the markets should not come as a surprise. 

Nonetheless, no investor will simply accept the value of their money going in reverse. Telegraph Money takes you through the best ways to organise your investments and get ahead of changes in markets.

Do not shift into cash

Often an investor's first instinct is to sell out of stocks into cash. This has its merits, as it means you limit your losses if markets continually fall, but there are important downsides to consider.

First, it’s hard to know what is merely a stock market blip and what is going to be a prolonged market fall. Selling out too early will simply incur costs and means you miss a rally.

Second, when you hold cash it means you are not invested when the bear market comes to an end. The subsequent rise in markets is often the most lucrative but cash holders will miss out.

Staying invested in markets through downturns may seem illogical, but had you invested in the British stock market the day before Lehman Brothers collapsed, often cited as the start of the 2008 financial crisis, by today your investment would still have risen 48pc.

Shift into different stocks

Investors can use the period before a recession to change the types of companies they own. 

Investors could benefit by shifting from the companies that have done well and are most susceptible to share price falls, such as US tech stocks, into defensive companies.

Defensive stocks, generally consumer staples, can see better share price performance than the market during falls as they are better placed to maintain profitability during an economic downturn.

However, these stocks can be expensive. Diageo, the maker of Guinness and Johnnie Walker, is a classic defensive stock but its shares currently trade at a price-to-earnings ratio (a popular measure of value) of 25, while the wider London market trades much more cheaply at 14 times earnings.

In times of need, however, paying over the odds to protect your portfolio can be a necessary evil. Among the funds that invest in this way, Lindsell Train UK Equity is often recommended by advisers.

Shift into the right funds

There are funds that invest across a range of assets, are designed to be defensive and protect the value of money when markets get rough.

These portfolios have built in a significant degree of protection against the ups and downs of the markets, but investors must sacrifice some long-term growth potential in return.

These are particularly useful for cautious investors who do not want to see their hard-earned savings potentially halve overnight.

See The Telegraph’s top 10 defensive funds.

Buy the dips

Falling markets naturally seem like a bad thing, but they also offer the opportunity for the savvy investor to buy assets at a cheaper price than their true worth.

Investors willing to hold some cash can take the risk and drip feed money into markets picking up cheaper assets along the way. This strategy will reap its rewards when markets turn and once-fearful investors pile back in pushing up share prices.

Do nothing

Despite all the panic, often the best decision is to ignore everything. Markets naturally rise and fall and even a 40pc fall in the stock market over the course of one month will be insignificant over a 20-year period.

If you are investing for the long term, such as your retirement, and have no need for your money, simply sit back and ignore the noise. Anyone who had money invested in global stock markets before the financial crisis has more than made their money back by now. So doing nothing can often be the easiest and best solution.