Investing during an economic downturn requires a different strategy than investing during prosperous times.

Adding to the complexity is that every economic downturn may be different. But whether the downturn is characterized by a dot.com crash or a plummeting housing market, these general strategies can help guide your investment direction during hard economic times.

Avoid Risky Investments

Risky investments require sophisticated knowledge and understanding at any time. If you are an average investor with little knowledge of riskier types of investments, the following investments should be avoided during normal times and especially during an economic downturn. These types of investments include:

- Futures trading 

- Options 

- Junk bonds

- Investment strategies utilizing leverage

Avoid an Over-Abundance of Low Risk Investments in Your Portfolio

During an economic downturn, it is tempting to give in to fear and pull your investments, or transfer them to low yield cash investments. Unless you are quite close to your target retirement date, you will lose money in a bear market when selling low. Financial advisors usually suggest resisting the temptation to put all your funds in low risk bonds or money funds.

The article “How to Protect Your Money Now” at http://www.kiplinger.com suggests that investors (excepting those within a few years of retirement) should keep 60-70% of their portfolio in equities, even during bear markets and tough economic times. The remaining percentage of the portfolio can be in short term, low risk investments, including: 

- Cash or savings accounts 

- Money market accounts 

- Certificates of deposit 

- Short term bond funds

Avoid Stocks that Depend on High Consumption

Consumers tighten their belts during tough economic times, leading to the following: 

- People consume luxury items less as they save more money.  

- People spend at a slower rate.

When consumers spend less, certain sectors may suffer. In an economic downturn, the following types of companies may see the value of their stocks decline:

- Companies that manufacture luxury goods

- Companies that depend on excessive consumer spending

- Companies that are tied to the housing market.

Avoiding these stocks may be a good strategy during an economic downturn, though there may be exceptions. For example, while a drop in home building during a recession may mean that an appliance company is selling fewer appliances in the United States, the same company might be increasing overseas sales. Before buying, research stocks at Web sites like http://www.morningstar.com.

Avoid Investing in High Priced Nonessential Consumer Goods

Unless you are flush with cash and have the rest of your needs adequately taken care of, economic hard times are not the time to spend money on expensive, nonessential goods. Examples of these might include: 

- High-priced electronic goods 

- Luxury items such as jewelry 

- Luxury boats, cars or other recreational toys

If you wait long enough and cover more important needs first, the cost of these nonessential items may come down more over time, making them a better deal in the future.

During an economic downturn, focus first on:

• Establishing a liquid emergency fund for your household. Many financial advisors recommend at least three to six months of living expenses in this fund. Articles on establishing an emergency fund are available at http://www.freemoneyfinance.com and http://www.bankrate.com.

- Paying off debt as soon as possible, and accruing no new debt. Articles at http://www.usnews.com and http://www.bankrate.com look at strategies for paying off multiple debts.

Avoid Investing without Diversification

Diversification is the key to spreading risk out in your portfolio, and hopefully minimizing that risk. This is true in a normal economy and especially true in a down economy. Minimize your loss by diversifying your investments.

Your approach to diversification will depend on factors including:

- Your goals for investing. For example: are you investing for retirement? If so, how close are you to retirement? If close, your diversification may be weighted more toward less risky investments.

- Your tolerance for risk. If you have a low tolerance for risk, your portfolio is probably diversified over a spread of relatively lower risk investments than an investor who prefers risk.

Whether you are a high-risk or low-risk investor, you can use diversification to spread your risk among your investments. If needed, consult a financial advisor to help factor in the aspects of your unique financial situation into your planning.

Some investors use index funds as one approach to investment diversification. An index fund is modeled to achieve a similar return as a market index (such as the S&P 500). The Securities and Exchange Commission at http://www.sec.gov has a description of index funds.

Additional Resources

- http://www.boston.com explores the complexity of a recession economy and the complex investments that can contribute to a downturn.

- http://www.thedisciplinedinvestor.com outlines strategies for investing in an economic downturn.