Market decline

6 ways to prepare for the next market downturn

The US economy is posting impressive figures in terms of GDP, jobs and wages, but many experts fear a slowdown is imminent. Fears of a trade war with China and the European Union remain at the forefront of the news. And the yield curve threatens to reverse, which means short-term interest rates could move higher than long-term rates. This is often a sign of an impending recession in itself.

By some measurements, the current expansion is now 10 years old, making it one of the longest on record. It sounds old, but there is no rule that says it cannot continue. Australia is in its 28th consecutive year of economic growth.

Even so, all good things come to an end. And for the United States (and Australia, for that matter), economists are looking for downturns. Even the Federal Reserve has indicated that it is ready to lower short-term interest rates to combat any problems that may arise.

Professional investment managers may be looking to sell a good chunk of their holdings to exit when the market drops. However, for most people, timing the market by selling when conditions look risky and buying when conditions strengthen is a big mistake. Even the pros aren’t always right, and they have armies of analysts and rooms full of tech at their disposal.

Here are six ways to prepare for the next market downturn. The key is to make small adjustments to your portfolio to reduce risk and always be ready to participate when the market resumes its bullish course.

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Sell ​​speculative stocks

Investors often have stocks in their portfolios that carry a bit more risk than they would like. What might have seemed like a good idea – think General Electric (GE) in 2015 – may have just been smoke and mirrors. The market has a way of punishing these types of businesses when times are volatile.

Uber investor Warren Buffett said: “You only find out who swims naked when the tide is coming out.” A bull market tends to hide the sins of weak companies; when the bear strikes, they are the first to be hit.

Even though this is not a disaster waiting to happen like GE was, some companies may simply not have the financial resources to withstand an extended period of hardship. They might have too much debt on their books. Or they could be in a cyclical business, like steel or oil drilling, which will seriously contract if the economy stumbles. Maybe you have shares in a company where legal battles, instead of increasing their market share, are making headlines.

If you get nervous about the health of the stock market, dig into some of these weaker positions.

Here’s a quick test: Any stock that hit a 52-week low in April or May when the Standard & Poor’s 500 index hit a 52-week (and all-time) high is likely to fail. not well in the event of a market downturn. The same goes for stocks at 52 week lows to today’s highs.

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Raise more money

Hands giving & receiving money - US dollar (or USD) bills

Raising more liquidity simply means reducing the overall size of your invested portfolio. This could mean selling speculative stocks, as mentioned above, but keeping the proceeds in a money market fund.

It could also mean reducing each sector of your portfolio by a fixed percentage.

Let’s say you have four mutual fund positions: a large-cap growth fund, a small-cap fund, a growth and income fund, and an international equity fund. (It doesn’t matter what they are, but this is a typical illustration of how investors can diversify between share classes.) If you cut each fund by 5% or 10%, keeping the cash proceeds, you reduced your risk without having to worry about the individual holding for sale. Of course, the percentage is up to you.

Remember that this is a twist from your wallet. You don’t time the market, for example, because you will stay heavily invested.

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Give more weight to defensive sectors

Ancient armor of knights, corresponding to another age

If you don’t want to take money out of the market, you can always reduce your risk by moving more money from aggressive to defensive sectors.

Aggressive sectors generally include technology, consumer discretionary and arguably financials. Defensive sectors typically include consumer staples, healthcare, and utilities.

What makes an industry defensive is that its businesses are less affected by economic fluctuations. Their products and services enjoy relatively stable demand and are the last that a consumer could forgo in difficult times. This includes food, medicine, and soap. Those big vacations and the flat-screen TV would be examples of discretionary items that are often the first to be cut from a budget.

Defensive sectors reduce your portfolio risk, but it comes at a price: When the market rallies, aggressive sectors typically outperform. The good news is that you will still be invested and you should see some payoffs without having to worry about the timing of your re-entry.

The strategy could be as simple as adding a small portion of the Select Sector SPDR Exchange Traded Funds (ETFs) in Consumer Staples (XLP), Healthcare (XLV) or Utilities (XLU).

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Increase allocation to bonds

A collection of United States Debt Certificates.

The portfolios benefit from a percentage of bonds or other fixed income investments. While bonds generally don’t offer the same potential for capital appreciation as stocks, their relative price stability and income streams can compensate for weakness in stocks.

A rule of thumb for a portfolio diversified across different asset classes is 55% stocks, 35% bonds and 10% cash. Of course, that will look a little or a lot different depending on your risk tolerance and how close to retirement you are.

But let’s just say you didn’t get this advice and you’re all in stock. The easiest thing to do is sell some of your stocks and buy high quality corporate bonds, Treasury bonds, or a mutual fund that invests in them. Remember: we previously considered raising 5% or 10% cash. Taking that money and moving it into a bond fund would go a long way in reducing the volatility of your portfolio and smoothing out your returns over time.

You don’t have to drastically change your portfolio all at once.

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Maybe a touch of gold

Gold bars, computer illustration.

If you follow the usual method of allocating your money among asset classes, you could hold 5 or 10% gold or other precious metals instead of cash.

Gold does not pay interest or dividends. What it does offer is hedge against several headwinds, including inflation, economic disasters, or war. None of these seem imminent, but if you’re really worried about the economy contracting sharply, a little gold would help you sleep better at night.

It might be worth the price, right there. But we can probably do better.

Gold stocks, that is, mining companies that seek out the yellow metal, are intimately tied to the price of gold, but they are still stocks. They can pay dividends, although most pay very little. But they have the potential for price appreciation, which means you can stay fully invested, if you so choose.

Transferring money to gold stocks is very similar to transferring money to other defensive areas. Gold is different enough to warrant its own consideration.

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Do not panic !

Photo taken in Spain, Malaga

Remember why you invested in the first place. You are trying to build wealth over time, not trying to enter and exit the market based on trade wars, interest rates, tweets, or pundits. This means that you will necessarily have to weather a few storms, but over time the stock market (and investing in general) is the biggest wealth-building machine.

For most investors, controlling risk is more important than trying to capture every move in the market. If you stick to strong companies under big global trends – life-changing technology, healthcare for the aging population, or new energy – and allocate a small chunk to that potential homerun, you may have a long and successful career. as an investor.

Control your risk. The rest will take care of itself.