Published Friday, September 20, 2013 at: 7:00 AM EDT
Let's be clear: There's no foolproof method for avoiding investment losses in a declining market. However, there are several sensible steps you might consider when markets are persistently volatile-as they have been for the past several years.
Consider these four practical suggestions:
1. Don't make any drastic changes in your allocation between "safe" and risky assets. For instance, if you're using a common 60/40 split between stocks and bonds and that still meets your goals, stick with that allocation. But you might consider changing the kinds of stocks and bonds you have within those allocations. Keep money you can't afford to lose in truly safe assets (or at least those that are as safe as financial assets can be) such as short-term bonds or cash. Remember that this protection may mean you receive little or no income. For the money you're willing and able to risk, you might look for stocks whose prices are relatively low compared with company earnings, rather than buying shares that offer the highest dividend yields. The latter may offer little potential for future share price growth.
2. Be suspicious of so-called "safety bubbles." Dividend-paying stocks have been popular and those shares have been buoyed by healthy corporate balance sheets, but their risk inevitably will increase. Shares of real estate investment trusts (REITs) and publicly traded master limited partnerships also have seemed relatively secure; yet their popularity, too, has made them expensive. A better alternative could be "low-volatility" stocks that may rise less than other shares during a bull market but could lose less when stocks fall. Also realize that the prices of fixed-income investments, which have been bolstered by the Federal Reserve's bond-buying programs, could decline when the Fed pulls back.
3. Keep in mind that there's no free lunch-in other words, even apparent safety has a cost. While dividend-paying stocks may have bond-like characteristics, their shares still will move up and down based on market conditions. And bond prices will suffer if interest rates rise or inflation accelerates.
4. When the market becomes especially volatile, investors seeking safety may want to forego high-dividend payers and move to parts of the market that seem cheap. For instance, if the price-earnings ratios of most U.S. stocks rise to suspect levels, safer alternatives could be available overseas. Although those shares, too, may fall if a bear market returns, their low valuations could help ease the pain.
Finally, don't hesitate to seek professional investment guidance. We can offer suggestions for your situation.
This article was written by a professional financial journalist for Advisor Products and is not intended as legal or investment advice.