2 Investing Moves I'm Making Right Now to Protect My Portfolio Against a Recession

Economic activity is fairly robust right now, in part due to the build-out of artificial intelligence (AI). So much so that the Federal Reserve felt confident enough to recently hike interest rates to rein in elevated inflation without being too restrictive on the economy.

However, since the Fed initially began hiking interest rates in 2022, investors have been bracing for a recession. After all, the economy experienced the longest inverted yield curve -- in which shorter-dated bonds yielded more than longer-dated ones -- in history. An inverted yield curve has long been a precursor of a recession. Furthermore, the market has been pumping higher since 2023, and affordability issues are rampant in the U.S.

While there are no imminent signs of a recession, things can change quickly. Here are two investing moves I'm making right now to protect my portfolio and prepare for a potential recession.

Image source: Getty Images.

1. Raise your cash reserves

Investors with a 10- to 30-year investing horizon don't need to adjust their portfolios right now, as timing the market is incredibly difficult. History is also not a guaranteed predictor of the future. That said, if you are concerned about a potential recession, raising some cash is never a bad idea.

Now, raising cash blindly without a plan is never the right approach. Think about your finances and what you need to cover your daily and monthly expenses, and make sure you have enough so that if your portfolio experiences volatility, it won't put you in a financial bind.

Investing is about saving for the future, not making speculative bets that are boom-or-bust. While accumulating wealth is important, it should not put you at risk of going broke. If you still hold stocks or funds that are reasonably valued and whose investment thesis remains intact and compelling, certainly continue to hold those.

Raising cash isn't just defensive positioning; it can also allow you to go on the offensive if and when a recession comes. Generally speaking, stock valuations are currently fairly high, so a recession could present a great opportunity for long-term investors to buy shares at a discount.

But as I mentioned, timing a recession is nearly impossible, so it's ideal to raise some cash while continuing to invest and still maintain a healthy portfolio.

2. Scrub your portfolio

Investors should raise cash meticulously. You should not blindly sell stocks, nor those you have made the most money from. There are several considerations.

Scrub your portfolio and examine all of your stocks, exchange-traded funds, and index funds. Are you holding individual stocks that you've made a bunch of money on and now trade at elevated valuations that don't leave a lot of margin for error? It might be time to take some gains. Or has the investment thesis behind a key holding changed? That's another reason to potentially sell.

There are also tax considerations. Stocks that you've owned for more than a year now qualify as long-term capital gains, meaning they qualify for lower tax rates than short-term gains. So it might make sense to sell these stocks over ones you've owned for less than one year, which would be subject to higher tax rates. Timing is also important for stocks trading at a loss.

Capital losses first offset capital gains of the same type (short-term against short-term, long-term against long-term). Any remaining net loss can offset gains, regardless of whether they are short- or long-term. If losses exceed gains overall, up to $3,000 of the net loss can offset ordinary income each year, and any excess losses can be carried forward.

Each year, many investors seek positions they can sell to offset their taxes in a practice known as tax loss harvesting, though it's more popular among institutional investors, who typically trade on shorter time horizons.

Scrubbing your portfolio is a good practice to undertake at least once a year. The world changes, and companies can be challenged by new competitors or shifting economic conditions. Investors should never become complacent or overly attached to a stock.

The Motley Fool has a disclosure policy.