The most frequently asked question I get, regardless of the economic outlook, the political party holding power, the market up or the market down, is, "I think the bottom is going to drop out, how do I protect my portfolio?"
While there may be many philosophies to accomplish this, they all really boil down to three strategies.
- Sell and go to cash. Obvious. Sort of. If you have a taxable account, that is you pay annually on your capital gains, losses, interest, and dividends, moving in and out of the market frequently can be costly in terms of taxes. All capital gains realized in under a year are taxed as ordinary income, not at the lower capital gains rate. Taxes can rob you of enough of your returns to be better off in the buy-and-hold camp. If, however, your portfolio is in a tax-deferred account like an IRA selling can make a lot of sense. This year, the stock market is up about 15% year to date. What's wrong with cashing in and being safe for a while waiting to see what happens? If you're right and the market has a major correction you can make really good money buying near the bottom and riding it up during the recovery. Why not? We all deny it applies to us, but the simple answer is greed, the kind of greed that says, "I don't want to miss out".
- Build a portfolio designed to weather market downturns. This is much harder to implement than one might think. Comes down to the "fear of missing out" factor that keeps investors from going to cash when they think trouble is ahead. Thinking they can squeeze a few more points of return from the market before the "big one" hits. A basic premise of the market is that the price of a stock is whatever someone is willing to pay for it. But the value of a stock can be determined with financial analysis. And while all firms have their own unique twist to valuation, earnings are a big component. Buying companies with stable earnings, even through recessions, can create a portfolio that is stable, relative to the overall market. Trouble is, in good times, investors put a lower premium on steady predictable earnings and a premium on speculation as to what earnings might be. This makes an earnings-based portfolio sometimes seem stodgy and underperforming. For taxable accounts, where you don't necessarily want to buy and sell frequently, it is a great solution that has historically rewarded patient investors.
- Hedging is simply a matter of adding investments to your portfolio that either historically or are designed to move independently or actually in the opposite direction of your portfolio. This adds a large degree of flexibility to portfolio. Historically gold has been a good hedge as well, but recent performance has not been as expected.
At FundTraderPro, our proprietary methodology aims to rotate your 401(k) selections into funds that yield positive returns on a consistent basis. Out methodology, has the capability to utilize all three strategies, depending on the options available to you in your 401(k) plan. By using all three strategies, our methodology has the ability to maximize returns in an upturn while minimizing the negative impact during a severe downturn. We review the options available in your 401(k) plan on a monthly basis to put you in the best position. That being said, there is no guarantee that any investment strategy will generate a profit or prevent a loss.
Currently, I'm in the bullish but worried camp. I strongly believe everyone should be prepared for another 40% or more sell-off. There are many things to be worried about. But I also feel the dominant market influence will be the government and the Fed. The Democrats know they are in trouble going into an election year. They are unlikely to let the economy slip into a recession. I think whatever stimulus doesn't pass this year, will be back up for discussion next year if the economy slows. Ditto the Fed. They will not slow their intervention or allow rates to rise significantly in an election year for fear of being accused of swinging the election. Any Fed action will be finished by the end of March 2022, if any is forthcoming.
Past performance is no guarantee of future results. All investing involves risk. Investments mentioned are not meant to be specific buy or sell recommendations without being taken in the context of an investors' entire portfolio or investment objectives. Consult an investment professional before investing.