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Strategies to protect your portfolio from a market crash
Signs are emerging that a stock market crash may be coming. The current 10-year bull market is the longest in history. The bond yield curve is trending toward an inversion, with longer term interest rates lower than short-term yields; historically, the inversion of the yield preceded many U.S. recessions. For example, the curve inverted in 2007 before the U.S. equity market collapsed. While the only guaranteed way to protect your money from the next crash is to avoid investing in the market, the average 9 percent stock market return from long-term investments may be worth it. If history is a valid guide, patient investors will profit from risking a portion of their money.
Reduce permanent capital losses.
When stock prices decline, investors must pause and think. “The most important strategy for investors worried about the next bear market is to reduce the risk of a permanent loss of capital,” says Daniel Kern, chief investment officer at TFC Financial Management in Boston. It’s natural to want to ease the pain of a stock market loss by selling and leaving the stock market altogether. Investors who make this fatal step, let their emotions dictate their decision-making and ultimately turn a temporary loss into a permanent one. Research shows that investors who sell after a market drop have lower long-term returns than those who hold on and wait for the market to rebound.
Prepare in advance for a stock crash.
Implementing well-respected portfolio management strategies and creating an appropriate mix of stocks, bonds and cash for one’s age, time horizon and risk tolerance can set investors up to handle the next stock crash. Gage DeYoung, founder of Prudent Wealthcare in Denver, found that a balanced portfolio of 50 percent stocks, 40 percent bonds and 10 percent cash would have lost about 19 percent of its value from November 2007 to February 2009 during the Great Recession; that's based on a study using financial planning software. A conservative portfolio with 20 percent stocks 50 percent bonds and 30 percent cash would have suffered a small 3 percent loss during that same time, according to his analysis.
Time the market.
Despite data disproving the success of market timers, there are some who win at this approach and adjust their portfolio as signs of a market collapse emerge. Steven Jon Kaplan, CEO of True Contrarian Investments in New York, sold his U.S. equities in 2018. Kaplan likes short-term U.S. Treasurys, emerging markets government bond funds as well as emerging markets and commodity producers’ stock funds. He also favors small-cap shares, citing its low valuations. For those less apt to actively time the markets, an asset allocation shift away from volatile stock market assets and into cash and bonds might make sense.
Invest in assets less correlated with the stock market.
Assets that don’t go up and down in tandem with the stock market, like real estate and commodities, might be appropriate to ward against a stock crash. Mihal Gartenberg, a licensed real estate agent at Warburg Realty in New York, says that real estate holds long-term value well, even during recessions. Since property is less liquid than financial assets, investors might look to real estate crowdfunding and real estate investment trusts for diversification. Chris Rawley, founder and CEO of Harvest Returns in Fort Worth, Texas, recommends investing like institutional investors in alternative assets like farmland. Agricultural investing doesn’t track the economy or markets and can hedge against inflation.
Let go of your need to control.
Some investors can’t help themselves and panic when markets tank. In this case, a financial advisor can be well worth the price. While a typical financial advisor can change more than 1 percent of assets under management to oversee an investment portfolio, lower cost alternatives are widely available. Robo advisories like Betterment, Personal Capital or Ellevest offer access to financial advisors who can keep an investment portfolio on track during good times and market drops. These fintech advisors charge less than 1 percent for advice. That said, Morningstar's research found that a good financial advisor can add approximately a 1.5 percent return to a managed portfolio, offsetting an annual fee.
Sell call options.
For an income stream and a hedge against market declines, Cory Bittner, chief operating officer at Kansas-based Falcon Wealth Advisors, recommends selling call options. A call option is a derivative contract that gives the seller, called the writer, the obligation to sell the underlying asset, usually a stock or exchange-traded fund, at a predetermined price during a specific time period. Regardless of the movement of the stock, the option seller keeps the option premium or payment. So if the option is exercised, a buyer purchases the stock. Then the option writer keeps the premium and the proceeds from the stock sale, softening the blow of a stock market in decline.
Steps to protect your portfolio from the next crash
Reduce permanent capital losses.
Prepare in advance for a stock crash.
Time the market.
Invest in assets less correlated with the stock market.
Let go of your need to control.
Sell call options.
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