6 Ways to Prepare Your Portfolio for a Down Market
Investing in the stock market involves risk and preparing for a bear market is crucial. Read Fifth Third Bank's 6 tips on how to prepare your portfolio.
Investors have been attempting to predict market swings for as long as there have been markets. And as we head into the eleventh year of the current bull market, people are understandably questioning how long it will last—and whether they should make changes to their portfolio.
Only time will answer the first question. With the current bull beginning in March 2009, we’re currently in the longest bull market on record. However, with the recent market rout caused by the coronavirus, even the Federal Reserve is taking note of the potential for an economic slowing due to a potential global pandemic. In response, the Federal Reserve cut interest rates in early March, hoping to ease some of the impacts.
Even with the specter of a down market, the question of whether you should alter your portfolio in response is nuanced—you should create a portfolio that first and foremost works for your long-term goals while accounting for the fact that markets change. The result is a sensible allocation that fits with your investment timeline and remains in a good position if we do experience a dip.
Market Ups and Downs
At the beginning of 2019, many were resolved that a bear market was inevitable—they believed the current bull had gone on too long and various economic indicators pointed toward a potential slowdown. However, global stocks closed with one of their best years ever in December, surprising a lot of investors and analysts who believed the choppy performance would lead to a more long-standing dip.
In 2020, the sentiment has been different. Until recently, the stock market has remained strong, posting gains even amidst political turmoil, tariffs, and other economy-altering events. The rise of the coronavirus in early March, though, has rightly concerned investors and global policymakers. The latter reported that the pandemic could slow global economic growth to 1.5% from the forecasted 3% for the year, and potentially throw Asia, Europe, and the U.S. into a recession.
Further down the road, other events promise to cause some market movement. For example, the presidential election also always gives investors pause, as people try to predict the outcome and potential impact on the economy. Predicting the future isn't possible, but given the current volatility, investors should expect some increased risk in th near-and-mid-term. Ideally, any significant market dip will be short-lived, but if not, it’s smarter and more proactive to ready for movement so that you’re not caught off guard.
Preparing for Volatility
Creating a portfolio primed to withstand some market movement mostly means lowering the impact of market volatility. There are several ways to do so. Consider:
Reducing the Equity Allocation in Your Portfolio
The percentage of your portfolio dedicated to equities is usually a function of your risk tolerance and time horizon. Naturally, those with shorter time horizon—such as people nearing retirement—will have a smaller equity allocation than those who plan to keep their money in the markets longer. That said, reducing your allocation to volatile equity markets even by a small percentage provides protection when the markets do take a dip. You can shift some of the equities into cash, and hold a reserve for making future investments.
Refocusing on Domestic Equities from International
If you want to maintain your equity position, then review the types of equities you’re holding. If you’ve invested in international funds or specific stocks, then consider whether any are at specific risk, given the international news. For instance, if you’ve heavily invested in companies that do business in China, such as car manufacturers or other industrial companies, then evaluating the risk of those equities in light of coronavirus is smart.
Shifting Into Mid and Large-Cap Equities
As expected, small-cap equities tend to be more volatile (they’re also often more affordable, and can provide big gains if you choose right). But for investors battening down the hatches of their portfolio, a move toward quality, large-cap, well-known stocks makes sense. In all cases, investing in small, medium and large-cap funds instead of individual stocks also reduces some of the overall risks.
Prioritize Dividend-Paying Stocks
In an exciting bull market, growth stocks are always a draw. However, moving from growth stocks to dividend-paying stocks provides another measure of protection during a downturn. That’s because even if the stock share price drops, the company will continue to provide a dividend to shareholders. In addition, the share price of classic blue-chip stocks will likely decline less than overvalued growth stocks, which have benefited from a rising market.
Shift Into More Bonds
Bonds are renowned for their stability and provide investors a safe place to earn a small return and sidestep some of the risks of a bear market. That said, there are various bond strategies to consider and you should work with your advisor to determine how specific types of bonds and bond funds can offer downside protection to your portfolio.
Consider Less-Risky Sectors
Some sectors traditionally weather stock market dips better than others. For instance, utilities and telecommunications tend to be less volatile than say tech. Real estate is less correlated with the stock market and real-estate-related stocks or REITS offer some good alternatives to traditional equities.
No one likes the specter of a market downturn. But the reality is that markets move up and down. By taking some proactive measures now, you can reduce your risk and limit the effect that big markets swings have on your investments.