Bear markets, recessions, and market downturns are largely unpredictable by their very nature. Here we’ll look at the best defensive ETFs to weather the storms and survive or even thrive during periods of market turmoil in 2023.
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Introduction – Being Defensive During Bear Markets
Attempting to time the market – predicting bear markets and recessions – is usually more harmful than helpful. What we can do, however, is prepare ahead of time by assembling a diversified, defensive portfolio of different assets, geographies, and equity styles.
The key to portfolio diversification is in holding uncorrelated assets. For example, when stocks go down, bonds tend to go up. Diversification seems to be the only free lunch in the market in that sense. Diversification is particularly important for investors with a short time horizon or low risk tolerance.
Warren Buffett’s #1 rule is “Never lose money.” Mitigating drawdowns preserves capital. Black swan events and even extended bear markets and recessions are largely unpredictable, but there’s no reason to simply withdraw to cash out of fear. The defensive ETFs below help increase portfolio diversification and provide downside protection so that risk-averse investors can have peace of mind during periods of market turmoil.
Historically, there have been specific defensive asset types and sectors that are more resilient to bear markets and recessions, some of which are colloquially referred to as “crash-proof.”
- Consumer Staples
- Treasury bonds
- Put options
- Low volatility stocks
- Inverse ETFs
Below we’ll explore the best defensive ETFs to capture these assets.
The 7 Best ETFs for Bear Markets and Recessions
Below are the 7 best defensive ETFs to stave off drawdowns.
FUTY – Fidelity MSCI Utilities Index ETF
Demand for utilities like water and electricity stays relatively constant during recessions and bear markets. These services are usually the last expense consumers cut. Consequently, utilities rarely experience drops in revenues, and are thus considered defensive stocks. The sector is also popular for providing consistent and high dividends.
The Fidelity MSCI Utilities Index ETF (FUTY) seeks to track the MSCIUSAIMIUtilities Index and has an expense ratio of 0.08%.
VDC – Vanguard Consumer Staples ETF
Similarly, demand for consumer staples – everyday products that people need like dish soap, deodorant, toothpaste, food, beverages, etc. – is non-cyclical and doesn’t change much during economic downturns, as consumers are unwilling or unable to stop buying these products. Thus, consumer staples stocks like Johnson & Johnson and Procter & Gamble tend to weather storms well and are considered to be “defensive” stocks. These stocks also usually maintain a consistent dividend payment during recessions and bear markets. Like utilities, consumer staples have the added benefit of being lowly correlated with the broader market.
The Vanguard Consumer Staples ETF (VDC) has over $6 billion in assets and over 90 holdings across the U.S. consumer staples sector. The fund seeks to track the MSCI US Investable Market Consumer Staples 25/50 Index and has an expense ratio of 0.10%.
VGIT – Vanguard Intermediate-Term Treasury ETF
Treasury bonds offer the lowest correlation to stocks of any asset type, and are considered a flight to safety asset since they’re backed by the U.S. government. Treasury bonds are the go-to diversifier to add downside protection and volatility reduction in a diversified investment portfolio alongside stocks. The popular 60/40 Portfolio shows how well this relationship has worked for decades. When stocks go down, bonds tend to go up. This relationship is conveniently amplified during market downturns and periods of high volatility, during which investors usually flock to treasury bonds for safety.
The Vanguard Intermediate-Term Treasury ETF (VGIT) roughly matches the average maturity of the total U.S. treasury bond market, and is a one-size-fits-all bond duration between short and long, suitable for any investor. This ETF has over $10 billion in assets and a low expense ratio of only 0.05%.
SGOL – Aberdeen Standard Physical Gold Shares ETF
Commodities are also considered a safe asset during market turmoil, the most popular of which is gold. The shiny metal acts as a store of value and performs well when the value of fiat currency is on the decline. Uncertainty in the market and/or falling stocks usually have investors running to gold, at least for a small part of their portfolios. Gold has a special diversification benefit of being uncorrelated to both stocks and bonds.
The Aberdeen Standard Physical Gold Shares ETF (SGOL) is physically backed by gold bullion. This ETF tracks the spot price of gold bullion and is the most affordable gold fund out there with an expense ratio of 0.17%.
TAIL – Cambria Tail Risk ETF
TAIL from Cambria rolls slightly out-of-the-money (OTM) put options on the S&P 500, which are basically an insurance policy that pays out in a major crash. The fundholds mostly intermediate nominal and real treasury bonds to help pay for the premiums of the small allocationof put options. I mentioned it when discussing tail risk here.
I don’t want to get too in the weeds on options specifics, but OTM options are cheaper and possess greater convexity. But because of this, we would only expect them to pay out big in aseverecrash, not necessarily in a minor market dip.
TAIL has a little over $400 million in assets and a fee of 0.59%.
USMV – iShares Edge MSCI Min Vol USA ETF
Speaking of low volatility, we can specifically target that factor with a popular fund from iShares: the iShares Edge MSCI Min Vol USA ETF (USMV). Funds like this allow investors to stay in stocks while reducing portfolio risk and minimizing drawdowns during bear markets and recessions. This fund finds stocks in the market that exhibit low volatility, ranks them, and then also looks at their expected future volatility before deciding whether or not they make the cut.
This ETF has over $34 billion in assets and an expense ratio of 0.15%.
SH – ProShares Short S&P 500
True bears may simply prefer to directly “short,” or bet against, the market. This can be done with inverse ETFs. These products use swaps and debt to provide the opposite return of the underlying index. In this case, if the index drops by $1, your position increases by $1.
The ProShares Short S&P 500 (SH) provides the inverse return of the S&P 500 Index. The fund has nearly $3 billion in assets and an expense ratio of 0.89%.
Where To Buy These Defensive ETFs for Bear Markets
All these defensive ETFs should be available at any major broker. My choice is M1 Finance. M1 has zero trade commissions and zero account fees, and offers fractional shares, dynamic rebalancing, intuitive pie visualization, and a sleek, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.
Interested in more Lazy Portfolios? See the full list here.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.
Don't want to do all this investing stuff yourself or feel overwhelmed? Check out my flat-fee-only fiduciary friends over at Advisor.com.
What ETFs should I invest in 2023? ›
- An exchange traded fund, or ETF, is a basket of investments such as stocks or bonds.
- The best-performing ETFs for February 2023 are Invesco Solar ETF (TAN), First Trust NASDAQ Clean Edge Green Energy Index (QCLN) and SPDR S&P Semiconductor ETF (XSD).
XLP, XLV, & XLU represent top recession ETFs in 2023 in my opinion. History suggests these sectors can outperform in bear markets. Healthy dividend yields and strong underlying businesses in the funds can mean ballast for a defensive portfolio.What is the best defensive ETF? ›
- Vanguard Consumer Staples ETF.
- Consumer Staples Select Sector SPDR® ETF.
- Invesco S&P 500® Eql Wt Cnsm Stapl ETF.
- Fidelity® MSCI Consumer Staples ETF.
- First Trust Nasdaq Food & Beverage ETF.
- iShares US Consumer Staples ETF.
- iShares Global Consumer Staples ETF.
|Vanguard 500 Index Fund||(NYSEMKT:VOO)||$744.8 billion|
|Invesco QQQ Trust||(NASDAQ:QQQ)||$145.9 billion|
|Vanguard Growth Fund||(NYSEMKT:VUG)||$132.3 billion|
|Avantis Small-Cap U.S. Value ETF||(NYSEMKT:AVUV)||$4.72 billion|
|XSD||SPDR S&P Semiconductor ETF||191.91%|
|QCLN||First Trust NASDAQ Clean Edge Green Energy Index Fund||176.69%|
|SMH||VanEck Semiconductor ETF||144.16%|
|SOXX||iShares Semiconductor ETF||140.42%|
While no investment is guaranteed to be recession-proof, some tend to perform better than others during downturns. These include health care and consumer staples stocks (or funds tracking those sectors), large-cap stocks and income investments.What is the safest investment during a recession? ›
That said, if you have cash to invest, you may want to consider buying recession-friendly sectors such as consumer staples, utilities and healthcare. Stocks that have been paying a dividend for many years are also a good choice. These tend to be long-established companies that can withstand a downturn.What are the best funds for a bear market? ›
Invesco S&P 500 Low Volatility ETF
One of the most popular types of funds for a bear market is low-volatility ETFs. The objective is pretty straightforward: Invest in stocks with low volatility, which should limit downside during a down market.
Amid this, investors might consider buying quality ETFs, Vanguard Short-Term Corporate Bond Index Fund (VCSH), JPMorgan Ultra-Short Income ETF (JPST), and SPDR S&P MIDCAP 400 ETF Trust (MDY) to ensure steady returns for 2023 and beyond.What stocks will boom in 2023? ›
- HAL-0.06 (-0.15%)
- ENPH-0.15 (-0.07%)
- NOC-0.94 (-0.20%)
- VFC+0.04 (+0.16%)
What sector will do well in 2023? ›
- Energy. Information. technology. Health care. Utilities.
- Real estate. Materials. Industrials. Communication. services.
- Consumer. staples. Consumer. discretionary. Financials.
Is now a good time to invest in index funds? Whether the market is down or up, now is always a better time to start investing than later — as long as you're investing for the long-term in a well-diversified portfolio. If the market is down, it's essentially on sale, and you can pick up the same index fund for less.