Nervous about the stock market crash? 3 ways to protect your portfolio
Markets are in correction territory with the S&P500 down 15% and the Nasdaq Composite down 23% year to date as of this writing. And many Americans fear the worst is yet to come, according to a new poll by alliance life insurance.
The recently released quarterly Market Perceptions study found that just 47% of respondents believe the economy will improve in 2022, up from 54% last quarter, and 60% fear a recession is imminent.
In the markets, 56% of respondents are worried about another “major market crash” – up from 50% last quarter – while 81% expect volatility to continue throughout the year. Perhaps the most surprising statistic from the survey is that 43% said they were too nervous to invest in the market now, up from 34% last quarter. That’s the highest percentage since 2019, according to Allianz. Additionally, 66% wish they had made their profits at market highs.
Those investors who are still in the market are looking for security, according to the Allianz survey. Specifically, 59% of respondents are looking for ways to better protect their portfolios. Here are three simple ways to protect your portfolio from whatever the market has to offer.
1. Diversify, don’t linger
When the market falls, as it has over the past six months, the knee-jerk reaction is to constantly review your portfolio — I just did this morning. However, avoid this because ultimately your focus should be on the long term. Focusing on short-term volatility could lead to hasty decisions that hurt your long-term performance.
A better approach is to take a strategic look at your portfolio and make sure it’s constructed to weather volatility and generate solid returns that meet your goals.
A good way to do this is to have a diversified portfolio of stocks that perform differently in different market cycles. While some of your tech and growth stocks have lost obscene value, some stocks in other sectors or value stocks may be doing well. For example, as of this writing, the S&P 500 is up 1% over the past 12 months, while small-cap Russell 2000 has fallen by almost 16%. In terms of growth vs. value, the Russell 1000 value The index is up about 1% over the past year during the Russell 2000 growth The index is down 24%.
You can also look at sectors. Year-to-date, stocks in the energy sector are up significantly, while communications services and information technology are down 15% or more.
Learn how different market segments perform in a given market cycle. And if you’re unsure of the best bets in a particular segment, there are thousands of exchange-traded funds (ETFs) that can give you a diversified basket of stocks in a specific sector or investment style.
2. Check your assignment
If the wild swings in the market are worrying, you can also dampen that volatility by adding bonds to your portfolio. Fidelity Investments recently conducted an analysis of returns during the 2008-2009 market crash for two different portfolio types – one with 100% stocks and one with 70% stocks and 30% bonds. The all-stock portfolio declined about 50% from January 2008 to the February 2009 market bottom, while the diversified portfolio declined about half.
If you look at performance between January 2008 and February 2014 – through the crash and the recovery – both portfolios performed about the same. This tells you a few things. First, the diversified portfolio offered a smoother ride and still delivered the same returns as the equity-only portfolio. Second, the all-stock portfolio eventually recovered from the sharp downturn and posted faster growth after the bear market. If you had sold bottom, you would not have benefited from this rally. And third, patience is rewarded.
Additionally, a study by Vanguard examined the average annual returns of various portfolios from 1926 to 2020 and found that the average annual return for a balanced 50/50 portfolio of stocks and bonds over that period was 8.7%. The best year saw a 34% return, while the worst year declined 23%, with 20 out of 95 years posting negative returns. An aggressive portfolio that was 80/20 stocks and bonds had an average annual return of 9.8%, 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 year was a 10% decline. Only 16 of the 95 years ended negatively.
3. Dividends are your friend
Dividend stocks pay investors a quarterly (sometimes monthly) cash distribution out of their earnings. Regardless of how well the stock price performs, dividend stocks pay you out every quarter. Dividend stocks tend to be large, established companies with solid earnings histories. About 84% of stocks in the S&P 500 pay dividends.
That’s why dividend stocks are important in falling markets. First, as mentioned earlier, you get the quarterly income if you don’t reinvest it. Second, when you reinvest the dividend, it helps boost your overall returns. Fidelity recently conducted a study that found that dividends have accounted for 40% of the S&P 500’s return since 1930. But during bear markets, they contribute much more to total returns. For example, dividends accounted for 71% of the S&P 500’s total return in the 1970s. By comparison, they accounted for just 16% of returns during the 2010s bull market.
These are troubling times, but patience and a solid strategy can help you weather a stock market correction.