How to prepare your portfolio for a stock market crash
A harrowing episode in the annals of regretful decisions: In early 2020, fear over the on-rushing pandemic made the S&P 500 tumble by a third. Some investors, with visions of their money evaporating, bailed out of stocks. When the market came galloping back, these poor souls had to pay dearly to restore their holdings, far more than they bagged when they exited. Many are still playing catch up, as the S&P 500 has jumped 110% since the index’s March 2020 low point.
How can you arrange your investments to withstand the next market crash?
Stay put. A well-constructed plan will bounce back and expand nicely in time from a crash. Panicky investors like last year’s stock unloaders now rue their decisions. Over the past three decades, the S&P 500 has grown 12-fold, not counting inflation. During that time, three major crashes occurred: the 2000 dot-com plunge, the 2008 financial crisis and the 2020 coronavirus market panic. And yet, those who hung onto their investments came out way, way ahead.
Go heavy on stocks. Notice that crashes are mostly the realm of stocks. The paradox is that stocks, while risky, are the essential building blocks of wealth. Nothing appreciates as fast and over such long periods as equities. Think of them as protein—vital for growth and muscle function, but unhealthy as one’s only food intake.
Diversify well. A drop in one sector is offset by a rise, or at least stability, in another. But asset allocation requires care. Too often, people’s portfolios are skewed. A recent Vanguard Group study found that the median household had 63% in stocks, 16% in fixed income and 21% in cash. That’s far too much in cash, which pays almost nothing in interest (from bank savings accounts or money-market funds). And likely this allocation has too little in bonds, whose interest rates are higher. The time-tested allocation is 60% in stocks and 40% in bonds.
Understand bonds’ role. You need that decent dollop of bonds for ballast when stocks nose-dive. But don’t look for much in the way of price rises from fixed income nowadays. Starting in the 1980s and until recently, bonds did fairly well. That’s because interest rates were coming down, and rates move in the opposite direction from bond prices. Now, rates are on the way up. After a while, though, bonds will likely keep you ahead of inflation, with a small bit of price appreciation thrown in.
Favor index funds. By definition, they automatically follow the market, very often the S&P 500. That’s why they charge lower fees than funds that actively pick securities. The so-called actives require well-paid staffs to do the picking. For years, the S&P 500 has creamed actives. Lately, 82.5% of large-cap actives failed to beat the benchmark index.
Get help. First, realize that everybody’s circumstances differ. Your age, your expected retirement date, your family obligations (offspring’s college expenses, for instance), your location (Napoleon, Ohio, is cheaper than New York City) and so on. Given all this, it pays to ask the pros to crunch the numbers for you, meaning financial advisors. The online advisor services like Betterment have low minimum investments, or for more tailored in-person advice, try firms such as Edelman Financial Engines. They can help fortify your portfolio.
While talk abounds that a crash is coming soon, due to the market’s dizzying heights and various calamities like resurgent inflation, prognosticating one is not enough. As the great sage Warren Buffett put it: “Predicting rain doesn’t count, building the ark does.”
This story was originally featured on Fortune.com