Last week we addressed whether stocks were too expensive. While there are reasons to remain optimistic about stock prices going higher, there are also obvious reasons for concern. If you are nervous about funds already invested, you have options without selling out entirely. Following are six ideas to minimize risks of exposure to the stock market:
Revisit your financial plan.
Are there reasons to adjust your original conclusions? Maybe you lost your job and decided to call it early retirement. Have goals or objectives changed? Maybe a recent health scare shifted your outlook and priorities for you and your family. If not, stick to the financial plan. This is where the value of a plan becomes clear. Don’t have a plan? Create one, and use it as a guide in times like this.
Reduce your equity exposure back to the target.
The strong equity market gains over the last year have left most portfolios heavy on equity exposures, particularly if you haven’t been diligent about re-balancing. If your current equity allocation is above the target allocation, sell equities to get back to the target. If you don’t have a target, set one and write it down. Documentation is a great way to hold yourself accountable.
Reduce your target allocation.
Were your asset allocation targets set in a different time and place before COVID? It is possible your life situation has changed and your risk tolerances have changed as well. Where you were 100% equities before, it might be time to introduce less volatile fixed income assets to your portfolio, despite low rates. If you are currently at 70/30, consider moving that to 60/30 or lower. Asset allocations aren’t fixed for life and can change as your situation changes.
Set sell rules ahead of time.
This only works if you are disciplined enough to execute. You could select targeted market levels at which you would sell down a predetermined percentage of your equity allocation. For example, if the S&P is at 4,100, consider selling 1-2% of your equities for each 100 point increase in the benchmark. Move these assets to a fixed income strategy or leave them in cash.
Make sure your portfolio is diversified. One Nobel Prize winner said that “diversification is the only free lunch in investing.” Diversification of your holdings across asset classes minimizes the risks of loss to your overall portfolio and exposes you to more opportunities for return. A market Price/Earnings ratio reflects an average price for equity markets. Some sectors and styles will be cheaper and hold more potential than others. Be sure you allocate funds broadly across investing styles, company size, and geography to reduce your overall volatility.
Set aside cash.
Set aside any cash you expect to need in the next 1-3 years. Fund this by selling equities to the degree those cash needs are met. The rest of your long-term money can continue growing through any market downturns. This minimizes, or avoids entirely, the possibility you have to raise cash by selling equities when equity markets are down by 10-20% or more.