Nervous About a Stock Market Crash? 3 Ways to Protect Your Portfolio

The markets are in correction territory with the S&P 500 down 15% and the Nasdaq Composite down 23% year to date as of this writing. And many Americans are worried the worst lies ahead, according to a new poll by Allianz Life Insurance.

Its recently released quarterly Market Perceptions Study found only 47% of respondents believe the economy will improve in 2022, down from 54% last quarter, and 60% are worried a recession is coming.

In the markets, 56% of respondents are worried about another “big market crash” — up from 50% last quarter — while 81% expect volatility to continue throughout the year. Perhaps the most startling statistic from the survey is that 43% said they are too nervous to invest in the market right now, up from 34% last quarter. This is the highest percentage since 2019, according to Allianz. In addition, 66% wish they had taken their gains at market highs.

Those investors who are still in the market are looking for safety, the Allianz survey revealed. Specifically, 59% of respondents are looking for ways to add more protection to their portfolios. Here are three simple ways to protect your portfolio from whatever the market dishes out.

Image source: Getty Images.

1. Diversify, don’t dwell

When the market is tanking, as it has been for about the past six months, the knee-jerk reaction is to constantly check your portfolio — I just did it this morning. But try to avoid doing this, because ultimately, your focus should be on the long term. Honing in on short-term volatility could lead to rash decisions that hurt your long-term performance.

A better approach is to assess your portfolio with a strategic eye, making sure it is built to weather the volatility and generate solid returns that meet your goals.

A good way to do this is to have a diversified portfolio with stocks that perform differently in various market cycles. While some of your technology and growth stocks may be down an obscene amount, some stocks in other sectors, or value stocks, may be performing well. For example, as of this writing, the S&P 500 has gained 1% over the last 12 months, while the small-cap Russell 2000 is down almost 16%. In terms of growth vs. value, the Russell 1000 Value index is up about 1% over the past year, while the Russell 2000 Growth index is down 24%.

You can also look at sectors. Year to date, energy sector stocks have seen significant gains, while communication services and informational technology are down 15% or more.

Get to know how different segments of the market perform in a given market cycle. And if you are uncertain about the best bets in any given segment, there are thousands of exchange-traded funds (ETFs) that can give you a diversified basket of stocks in any given sector or for any investment style.

2. Revisit your allocation

If the wild swings in the market are unsettling, you can also temper that volatility by adding bonds to your portfolio. Fidelity Investments recently did an analysis of returns during the 2008 to 2009 market crash for two different portfolio types — one with 100% stocks and one with 70% stocks and 30% bonds. The all-stock portfolio was down about 50% from Jan. 2008 through the market bottom in Feb. 2009, while the diversified portfolio was down about half that.

When you look at performance between Jan. 2008 and Feb. 2014 — through the crash and recovery — both portfolios had about the same performance. This tells you a few things. One, the diversified portfolio offered a smoother ride and still delivered the same return as the all-stock portfolio. Two, the all-stock portfolio ultimately recovered from the sharp downturn and had faster growth coming out of the bear market. If you had sold at the bottom, you wouldn’t have benefited from that recovery. And three, patience is rewarded.

Furthermore, a study by Vanguard looked at the average annual returns of various portfolios from 1926 through 2020 and found the average annual return for a balanced 50/50 portfolio of stocks and bonds was 8.7% over that period. The best year saw a 34% return, while the worst year was down 23% with 20 of 95 years experiencing negative returns. An aggressive portfolio that was 80/20 stocks to bonds had a 9.8% average annual return with the best year up 45% and the worst down 35%. However, 24 of the 95 years were negative.

A portfolio that was 80% bonds and 20% stocks had an average annual return of 7.2%. The best year saw a 41% return, and the worst was down 10%. Just 16 of the 95 years ended in negative territory.

3. Dividends are your friend

Dividend stocks pay investors a quarterly (sometimes monthly) cash distribution from their earnings. So regardless of how well the stock price is doing, dividend stocks will pay you each quarter. Dividend stocks are typically large, established companies with a history of solid earnings. Something like 84% of the stocks on the S&P 500 pay dividends.

Here’s why dividend stocks are important during down markets. One, as mentioned, you get the quarterly income if you choose not to reinvest it. Two, if you do reinvest the dividend, it helps boost your total return. Fidelity did a study recently that found dividends have accounted for 40% of the S&P 500’s return since 1930. But during down markets, they add far more to the total return. For example, in the 1970s, dividends accounted for 71% of the S&P 500’s total return. By comparison, during the 2010s bull market, they only accounted for 16% of the return.

These are unsettling times, but patience and a solid strategy can help you navigate a stock market correction.

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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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