How to Prepare Your Portfolio for a Recession

“Bad losses in bad times.” That’s what author and investment advisor William Bernstein believes is a key risk for investors: the prospect of having to draw on their investment portfolios due to job loss or some other economic hardship at the same time their portfolios have experienced losses. Building a portfolio that will be resilient in varying economic conditions, including recessions, is a key reason that investors diversify their portfolios, and it was a topic we discussed in our recently published Diversification Landscape 2025 paper.

Recession loomed as a risk factor in 2023 and into 2024, as some market watchers believed that the Federal Reserve would overshoot in its efforts to stamp out inflation. The yield curve inverted, meaning that yields on longer-term bonds dropped below those of shorter-term bonds; such an inversion had historically been a harbinger of recession. Yet recessionary worries generally declined through 2024, thanks to still-robust gross domestic product growth and high levels of employment, and the yield curve returned to a more normal pattern of longer-term bonds yielding more than shorter-term ones. President Donald Trump’s tariff policies have stoked recession worries again in early 2025, and some economists have evinced concern about stagflation—the prospect of higher inflation amid slowing growth.

What Works During Recessionary Periods?

The economy’s inherent cyclicality points to the virtue of building a portfolio that’s resilient in the face of varying economic conditions. It’s therefore valuable to examine how various asset types have behaved in periods of economic weakness and which assets have helped diversify US equity exposure.

To do so, we examined eight recessionary periods in US history. It’s worth noting that the definition of a recession varies. While “recession” is often defined as two successive quarters of negative GDP growth, the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

Some of those economic downturns were abbreviated, such as the start of the pandemic in February/March 2020, and some were more prolonged, such as the Great Depression in the late 1920s and early 1930s. For each period, we examined the returns, volatility, and correlations of US large-cap stocks, US Treasury bonds, a 60/40 mix of the two assets, and a diversified portfolio of 11 asset classes including non-US stocks and bonds, commodities, gold, and REITs.

Not surprisingly, stocks frequently contracted during past recessions, losing value in five of the eight periods we examined. Some of those losses were severe, such as the 24% annualized loss for stocks during the global financial crisis of 2007-09. Stocks’ poor performance during such periods makes intuitive sense: Weakening economic growth translates into slackening demand and declining earnings growth for many businesses, especially those that sell discretionary goods and services.

In that same vein, bonds logged positive gains in all eight of those same periods of economic weakness. The explanation for bonds’ strength during recessionary periods is twofold. The Federal Reserve often cuts interest rates during such periods, which boosts bond prices. Moreover, investors often retreat to safety, stability, and liquidity in periods of economic insecurity (high-quality bonds and cash) and away from assets they perceive to be higher risk (equities).

The 60/40 and diversified portfolios’ returns and volatility levels, as measured by standard deviation, tended to fall between those two extremes during economic downturns. The balanced and diversified portfolios didn’t lose as much as the equity-only portfolio, nor did they fare as well as an all-government-bond portfolio would have done during those periods of economic distress. And the plain-vanilla 60% US large-cap equity/40% intermediate-term government-bond portfolio tended to outperform the diversified portfolio that included exposure to high-yield bonds, smaller-cap stocks, commodities, and other asset classes.

In other words, in an economic shock, the most basic government bonds often serve as effective ballast for equity portfolios. That’s borne out by correlation data as well. Bonds’ correlation coefficient with equities during recessionary environments ranged from strongly negative (negative 0.70 in the period from March 2001 to November 2001) to more positive (0.65 in the period from July 1981 to November 1982). Bonds have therefore provided a significant diversification benefit, even during periods when stock/bond correlations were relatively high.

Examining the Outliers

Yet as much as the data underscore the benefits of holding a plain-vanilla government-bond portfolio during recessionary environments, a few time periods stand out as outliers and are worthy of further examination. In three recessionary periods—January 1980 to July 1980, July 1981 to November 1982, and July 1990 to March 1991—stocks actually gained ground, and high-quality bonds did, too. In other words, stock market losses and bond market gains aren’t a fait accompli in every recession.

It is worth homing in on the two recessions in the early 1980s—the so-called “double-dip” recession—because they have some parallels with the recent past in the US. The Iran-Iraq war in 1980 caused energy prices to surge and led to broad-based inflation: In 1980, the inflation rate surged to nearly 14%. The Federal Reserve’s aggressive interest-rate increases led to high unemployment and two economic contractions—a mild recession from January 1980 to July 1980 and a deeper one from mid-1981 through 1982.

Despite those headwinds, stocks managed to post robust gains in 1980 and 1982, contributing to positive returns in both early 1980’s recessions. (Stocks did post a loss in 1981, however.) Stock market participants appeared to be looking through the bad news to better times ahead, including an end to rising inflation and interest rates, as well as a recovery in economic growth. They were also cheered by President Ronald Reagan’s tax cuts and regulatory rollbacks, among other factors.

Portfolio Implications

Of course, each time period is different, and the current economic environment is almost certainly different from that of the early 1980s. As noted earlier, the economy proved resilient even in the face of inflation and the Fed’s 11 interest-rate increases in 2022 and 2023, thanks largely to the health of the labor market and robust consumer spending. In early 2025, recessionary storm clouds have gathered once again; stocks have fallen but US Treasury yields have risen on some of the worst days for stocks, pushing down bond prices.

Overall, though, high-quality fixed-income assets have been a boon to portfolios in most recessionary environments. That is largely due to lower yields and investors’ desire for the stability and safety of fixed income and cash assets during periods of economic turbulence, both of which boost bond prices. While high-quality bonds won’t diversify equities in every market environment (see: 2022), they have historically been reliable in periods of economic weakness.