11 Ways to Help Reduce Risk in Your Portfolio
11 Ways to Help Reduce Risk in Your Portfolio,
See the full article here: by Charles Schwab Company
Sometimes it takes a stock market drop to get investors thinking about how to better protect their downside.
“An unattended portfolio may have become more aggressive as the stock portion outperformed the other asset classes and ended up accounting for more of the overall portfolio value,” says Mark Riepe, senior vice president at the Schwab Center for Financial Research. “That’s fine as long as stocks keep going up, but conditions can turn around quickly... When they do, you may not be prepared, either financially or emotionally, to tolerate a sharp decline in your portfolio.”
To arm yourself against a potential market downturn, you may want to reexamine your investing strategy through the lens of your current risk appetite and time horizon.
Before you make any adjustments to your holdings, make sure your financial plan is up to date:
- Does your portfolio mix still match your risk tolerance?
- Does your risk tolerance still match your goals?
A spike in volatility can remind investors why it’s often wise to take a more conservative stance the closer you get to retirement—by shifting from stocks into bonds and other fixed income investments, for example. Indeed, those in or near retirement may want to keep enough cash on hand to cover two to four years’ worth of spending needs (after accounting for other sources of income, including Social Security). This degree of financial flexibility can help investors manage unforeseen expenses without having to liquidate stocks under less-than-ideal conditions.
On the flip side, if retirement is at a comfortable distance, you shouldn’t be too spooked by swings in the market. You may have sufficient time—so long as you stay invested—to wait out a downturn and capture the longer-term gains that stocks have historically delivered.
By all means, reassess and rebalance, but don’t forget to stay calm while doing so. Trying to dump investments when the market is dropping is a great way to invert the old adage about buying low and selling high.
If the head-for-the-exits feeling is familiar, you may be the kind of investor who would benefit from a more conservative portfolio—as part of your long-term strategy, not as a response to a market upset.
At the end of the day, though, staying invested to support your goals can help you avoid making decisions in the heat of the moment. Our research shows that even bad market timing beats sitting on the sidelines.
Here’s where four hypothetical investors who invested $2,000 a year would have ended up after 20 years.
Source: Schwab Center for Financial Research. Investors A & C put their yearly contributions in T-bills while waiting to invest in the stock market. The chart shows average 20-year ending wealth over all 20-year periods between 1926-2017. The stock market is represented by the S&P 500 Index with all dividends reinvested. The example is hypothetical and provided for illustrative purposes only and the example does not reflect the effects of taxes or fees. Past performance is no guarantee of future results.
Moves you can make
If, after reassessing your plan and rebalancing your portfolio, you want to take an even more defensive stance, there are other minor adjustments you might make. Specifically, you could bump up your holdings of less-risky asset classes and trim your long-term allocation to riskier ones. For example:
- Cash: Generally speaking, your upside with cash is limited, but it retains its value in the face of even the steepest market declines. And cash tends not to move in lockstep with changes in the prices of other kinds of assets. “Cash is the ultimate defensive asset,” Mark says. “Plus it’s great way to hold an emergency fund. Even aggressive investors should consider keeping at least 5% of their portfolio in cash.”
- Consumer staples, health care and utilities: When the economy slows, companies that sell products most people need regardless of the state of the economy—think food, prescription drugs and other household necessities—tend to lose less value than those that produce nonessential products. Owning these and other so-called defensive stocks can be a good way to potentially capture at least some of the market’s gains while remaining relatively protected from its bigger swings.
- Gold: The precious metal has a history of holding its value—and even rising—when other asset classes are under pressure. In fact, it was one of the few investments with positive returns during the worst days of the 2008–2009 financial crisis. Keep in mind, however, that while gold and other precious metals can shine when market conditions are uncertain, their prices can be volatile.
- Treasuries: Backed by the full faith and credit of the U.S. government, these are the safest fixed income investments you can own. Short-term Treasuries (which mature in a year or less) or intermediate-term Treasuries (which mature in less than 10 years) can provide decent income with low risk. Longer-term Treasuries may offer even more income, though their prices could take a hit if interest rates continue to rise.
- Corporate and high-yield debt: The value of outstanding debt owed by businesses outside the financial sector has nearly doubled over the past decade, to a record $9.8 trillion,* as companies capitalized on historically low interest rates—raising concerns of a potential bubble.
- Emerging-market stocks: Slowing growth in developing countries has helped stoke some of the recent market turmoil. China, for example—the mother of all emerging markets—is growing its economy at its slowest pace in more than a decade, with ongoing trade tensions (as of publication) threatening to make matters worse.
- Small-cap stocks: Publicly traded companies with a market capitalization ranging from roughly $300 million to $2 billion tend to be more volatile than their large-cap counterparts, particularly during a downturn.
- Tech stocks: Large-cap technology stocks such as Apple, Alphabet and Microsoft led the market to new heights over the past decade, but when markets turned volatile in late 2018, these stocks fell fast. Apple shares lost 31% in the fourth quarter of the year, for example, compared with a 14% drop for the S&P 500.
De-risking the right way
There are a lot of ways to dial back the risk in your portfolio. The idea is to embrace these options in appropriate amounts.
For example, taking a more aggressive tactical approach might be right for investors with the inclination, time and skills to watch the market closely. But if—like most investors—you’re focused on the long term, one of the best ways to play defense is to maintain an asset allocation that matches your time horizon and risk tolerance.
If you do decide to add or trim exposure to certain asset classes, make sure you’re doing so in response to your needs and goals—not because of short-term market gyrations. The goal is to follow a strategy you can live with through the ups and downs.