The stock market is getting a bit nerve-racking for some as concerns deepen that the U.S. Federal Reserve may start raising interest rates at the same time the economy is slowing down.
That scenario didn’t work out so well in late 2018 and investors are getting increasingly worried about a repeat.
However, those same investors have been spoiled the last 18 months or so with some spectacular gains.
If the recent market moves are more than just a healthy pullback and a severe downturn is coming, are you and your portfolio ready?
Here are some ways to protect your capital.
by Al Emid, NextAvenue.org
Sleeping well is the second goal of investing and becomes easier with the right preparations. (The first goal is not to lose money and the third goal is to make money.)
By taking the right precautions now, you can sleep soundly when the stock market drops precipitously and stays there for a while, something that’s bound to happen sometime.
“The proverbial Wile E. Coyote moment lays ahead,” says James Athey, investment director at Aberdeen Standard Investments in London, referring to the speedy roadrunner who looks down to see that he has run off a cliff, realizes he no longer has ground beneath him and plummets.
What’s behind fears of a stock market correction
Stock market volatility, caused by a range of factors including worries about inflation, interest rates and supply chain problems, amplify fears of a coming market correction (that’s a drop in stock prices of more than 10% but less than 20%) or even a crash (a sudden and precipitous drop).
Preparing for a correction starts with understanding the inevitability of small-sized corrections and lesser likelihood of a major correction, says Alex Klingelhoeffer, a financial adviser at Oklahoma City-based Exencial Wealth Advisors.
“A correction is always around the corner,” he notes. “Typically, we have a garden-variety correction once every 18 months.” Deeper corrections happen less frequently.
“What keeps folks up at night is the big one. Major corrections of more than 20% have happened seven times in the last 100 years,” Klingelhoeffer says. They were in 1929, 1937, 1939, 1946, 1973, 2000 and 2007.
The best defence for investors
Diversification is the best defence. That means having enough cash and bonds in your portfolio to cover all foreseeable expenses for five years.
That means trading off the low income generated by those assets against having to sell off stocks eroded by a correction.
The current 1.21% interest rate on, say, five-year Treasury bills “is a terrible rate,” Klingelhoeffer says, but “if the market corrects and you have a 30% drop, your bills are not going to drop.”
Stable sources of income such as salary, pensions and Social Security can reduce the total amount you might want in cash and near-cash holdings as protection against a stock market collapse.
It also helps to own stocks of international markets which might not fall as much as the U.S. market during a correction.
Real growth in the world economy is coming from these areas and they can provide opportunities and ballast for a U.S.-centred portfolio, especially when U.S. markets underperform.
Precious metals such as gold and investments in real estate can also provide some reassurance. “They’re not making any more land,” Klingelhoeffer adds.
He also favours investing some money in a basket of commodities, including wheat, corn and lumber.
“These are things that we use and need to live,” he says, adding that they have a low correlation to the overall stock market. You can invest in commodities through commodity exchange-traded funds or ETFs.
Investors may have some time to implement these strategies (though not an unlimited amount of time), since a major correction could occur over six to 12 months, according to Athey.
Image: WARNER BROS/EVERETT COLLECTION