Investors should avoid panicking about the possibility a market crash is looming. That said, you also don’t want to ignore the warning signs. Stock indexes are near all-time highs with richer valuations than historical averages. The market could be threatened by rising interest rates, pandemic-related impediments to business, higher inflation, shifts in fiscal policy, or lingering unemployment.
With all those headwinds swirling, this would be a wise moment to review your investments and make the necessary adjustments to manage your risk. Here are four tips for getting your portfolio into a safer place without sabotaging yourself.
When it comes to anticipating trouble in the market, overreacting can be worse than not reacting at all. Just because you’re worried about a crash doesn’t mean one is imminent. It could be months or years until we see another significant correction or bear market.
Even if there is a crash right around the corner, selling off your stocks now only makes sense if you can buy back in at the bottom. If you’re feeling skittish about staying invested while the market is still near its peak, then you probably won’t be bold enough to dive back in when post-correction doom and gloom still hangs over Wall Street. Making a well-timed reentry even more difficult, many of the best days in the market happen soon after their worst days. Even if you have the gumption to dive back into the market after a major sell-off, it’s extremely difficult to time that move properly.
In short, don’t let fear cause you to liquidate your holdings and hoard cash. Come up with a long-term investment plan, and stick with it. That should include long-term holdings you feel confident in through even the ups and downs of a volatile market. Then, you only have to make modest adjustments as you go when conditions change with the understanding that market cycles are temporary.
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Bonds are the most popular investment option for reducing volatility. While they do fluctuate in value on the secondary market, investment-grade bonds generally won’t experience price swings as wide as stocks do. These securities also don’t provide as much growth potential as equities, but holding them as part of a diversified portfolio can help you reduce losses in a market crash.
Again, you shouldn’t rush out and sell all your stocks so you can buy bonds instead. However, now is an opportune time to review your risk tolerance, your investing time horizon, and your current portfolio allocation. Based on the results of a risk tolerance questionnaire and your age, you can figure out how much of your portfolio should be allocated to bonds.
There are steps you can take to shore up your stock portfolio, too. In a broadly declining market, dividend stocks usually prove safer than growth stocks. Stable, mature companies that can afford to regularly return capital to shareholders often have less aggressive valuations, so they don’t fall as hard during corrections.
Also, shareholders can generally count on those quarterly payouts to produce income for them while they’re waiting for the market to recover. Companies can and do trim their dividend payouts when conditions require it, but even so, dividend stocks can still pay off for investors when their share prices are down. For those who rely on their portfolios to cover their near-term financial needs, it can give them the flexibility they need to wait out temporary downturns without selling out of their holdings at a loss.
Consider buying Dividend Aristocrats or a dividend-focused ETF. They’re good choices even if the market doesn’t decline, because these investments can also provide healthy returns through long-term price appreciation, even if they tend to lag growth stocks in bull markets.
Defensive companies are, by definition, relatively low-volatility businesses that aren’t so sensitive to economic cycles. Utilities, consumer staples companies, and healthcare companies focused on non-elective care are common examples. Whether the economy is shrinking or growing, these companies enjoy steady demand for their offerings and produce predictable cash flows.
Defensive stocks usually don’t have great growth prospects, so their shares aren’t as popular when the broad market is soaring. However, this also means they don’t have as far to fall when capital starts flowing out of the market.
This isn’t to say that defensive stocks don’t experience declines during market crashes — they can and will suffer losses. However, allocating an appropriate share of your portfolio to defensive stocks can help cushion it from the worst of the sell-off. Those investments will preserve more of your financial power, giving you more capital to deploy when it’s time to shift your allocation back toward growth stocks for the next bull market.
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