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Investing

7 Portfolio Protection Strategies to Guard Against Volatile Markets

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Stock market volatility is a fact of investing, especially in the short-term. While stock market returns tend to smooth out over time, trending higher overall, it can still be upsetting when you’re watching your portfolio performance during a stock market event or during times when there are wide swings in performance.

In times of volatility, many investors start looking for portfolio protection. If you’re worried about what’s next, here are seven strategies you can follow to help you weather the next storm.

1. Turn off the TV

“The first thing to do if you want to protect your portfolio is stop watching financial news,” says Roger Wohlner, a financial advisor, MagnifyMoney contributor and founder of the blog The Chicago Financial Planner. “It’s easy to get wound up and make decisions based on the stock market, and not based on your risk tolerance and portfolio needs.”

Wohlner points out that recessions and market downturns are regular parts of the economic cycle, and that it’s better to stick with your plan than to change everything the moment the news gets bad.

“You’ll probably need to make tweaks as you go along,” Wohlner acknowledges, “but you should make those changes because you’ve considered your plan, your needs, and the fundamentals of your portfolio, not because someone is yelling about it on TV.”

2. Get diversified

Diversification can be another way to engage in portfolio protection. One of the main tenets of Modern Portfolio Theory, the Nobel-winning theory introduced by Harry Markowitz, is that the asset class makeup of your portfolio matters more than the individual securities you choose.

With diversification, you protect your portfolio in the event that one particular portion of the market is hit hard. It limits the damage done when one asset class plummets, or if a particular sector underperforms.

In order to diversify your portfolio, it’s important to consider the following factors:

  • Types of assets (stocks, bonds, real estate, etc.)
  • Industries or sectors (retail, technology, utilities, etc.)
  • Geography (including non-U.S. assets, in addition to U.S.-based assets)
  • Time frame (including dollar-cost averaging)
  • Strategy (including growth vs. income, large-cap vs. small-cap, etc.)
  • Mutual funds and ETFs to take advantage of the market as a whole, rather than limit your portfolio to a small portion of the market

“Appropriate diversification can help you weather market downturns,” says Wohlner. “Make sure you’re not relying on a few individual stocks, or that you are too heavily invested in a particular industry.”

3. Add non-correlating assets

While the stock market offers ample opportunities for growth, the reality is that systemic risk is a real concern. There are times when the whole market drops, and portfolio protection is difficult in those circumstances.

Adding assets that don’t correlate with the stock market can be a way to introduce a measure of portfolio protection. Some assets that don’t necessarily move the same way as stocks include:

  • Bonds
  • Real estate
  • Commodities
  • Currencies

Additionally, cryptocurrencies are increasingly being seen as an asset class, and some investors like to use peer-to-peer loans as a way to introduce non-correlating assets to their portfolios.

Wohlner warns against relying too heavily on non-correlating assets, though. “Your best bet is still a portfolio constructed mainly of stocks and bonds,” he says. “But if you want to take a small portion of your portfolio and use it for other assets, that can be one way to reduce your risk.”

4. Use a bucket strategy

Wohlner is an advocate of using a bucket strategy to avoid the issues that come with a steep stock market drop. With the bucket strategy, you construct your overall portfolio based around when you need access to your money.

Money you think you’ll need within three to five years should be kept in cash and cash-like securities.

“When you plan it this way, you shift assets before market problems, and you have access to the cash you need without having to liquidate stocks when they’re down,” says Wohlner.

Other buckets include a medium-term bucket with dividend-paying stocks and other dividend-related investments, and a long-term bucket comprised mostly of money you won’t need for more than 10 years that is invested mainly in stocks.

A bucket strategy can be used as a rebalancing tactic to help keep your portfolio in line with your goals and needs, no matter what the markets are doing, Wohlner points out.

5. Consider adding dividend-paying investments

Dividend-paying investments can contribute to portfolio protection by adding to a security’s overall return, as well as providing an additional hedge against inflation.

Some investors like to use dividend aristocrats, says Wohlner, because they are companies that have increased their dividends every year for at least 25 years. Additionally, real estate investment trusts are known for their dividends and their ability to add exposure to another asset class in your portfolio.

Related to dividend investments is the ability to invest in businesses or start businesses to receive another revenue stream. “Anytime you can find additional types of revenue, you can protect your portfolio and your finances better, no matter the economic situation,” says Wohlner.

6. Look for principal-protected and inflation-protected assets

It’s also possible to look for assets that offer portfolio protection in specific ways. You can add assets that guarantee your principal as well as securities designed specifically to combat inflation.

  • Principal-protected assets guarantee that your principal will be safe. A principal-protected note is one example. Say you invest $500 in a note tied to the S&P 500. The note issuer would use a portion of the money to buy a zero-coupon bond and invest the rest in call options on the S&P. After maturity, you receive your principal plus your portion of any profits. If the S&P loses, you still get your original investment back.
  • Inflation-protected assets are designed to offer a return that at least keeps pace with inflation. Treasury Inflation Protected Securities (TIPS) are a good example. The interest rate you receive on TIPS adjusts with inflation, so your principal isn’t eroded by the impact of rising prices.

While these types of assets can provide you with peace of mind, they might not allow you to grow your wealth like you need to. “There’s nothing wrong with having a portion of your portfolio in these assets,” says Wohlner. “But you can’t rely on them completely to provide the portfolio growth you need.”

7. Use options to protect against volatility

Advanced investors sometimes use various options strategies for portfolio protection. While there are many different types of options, put options are popular because they allow investors the right to sell a stock at a certain price within a set amount of time. If a stock drops, profits from selling the option can offset the drop in price.

There are other options strategies that can be employed to protect unrealized profits and offset portfolio losses. However, these strategies themselves can be risky and Wohlner warns against becoming too reliant on options as a strategy to protect your portfolio.

Bottom line

For most investors, the best way to protect a portfolio is to come up with a plan that helps them achieve their goals and then stick with it, rather than selling stocks in response to a perceived crisis, according to Wohlner.

“You can rebalance as needed and change the plan as circumstances require, but most investors are better off preparing for inevitable downturns ahead of time with a good long-term portfolio strategy,” he says. “Anytime you’re making changes just because the market is doing something that scares you, chances are things will work out poorly for you.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Miranda Marquit
Miranda Marquit |

Miranda Marquit is a writer at MagnifyMoney. You can email Miranda here

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Investing

This Is When It Makes Sense to Rebalance Your Portfolio

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

One of the best ways to build wealth over time and meet your long-term financial goals is to create an investing plan using asset allocation — and stick with it.

At some point, though, market conditions can lead to your portfolio moving away from your planned allocation. When that happens, a portfolio rebalance is in order.

What is portfolio rebalancing?

In many cases, a portfolio contains a mix of assets to help you diversify while still allowing you to reach your goals.

“When we lay out a portfolio allocation, it’s because we understand the potential risk and return, and how to align it with client goals,” said Eric Roberge, a CFP and founder of financial education website Beyond Your Hammock. “Over time, though, an asset class can go up or down, doing well or underperforming. That can cause the portfolio to go out of balance.”

For example, your portfolio might rely heavily on stocks and bonds but have some diversification with real estate, commodities, and cash.

rebalancing portfolio

If one asset class is doing well, it starts to take up a more significant portion of your portfolio’s value, while a worse-performing asset will take up a smaller slice of the pie. If stocks are doing well, bonds and REITs are underperforming, the idea is to sell the stocks and then buy the assets that aren’t doing as well. You take the excess profits and purchase other assets at a lower price.

“The idea is that you’re forced to do what you’re supposed to be doing anyway,” said Roberge. “You sell high and then buy something else low.”

Roberge said that it’s a good idea to maintain the asset mix you decided on since it can help you continue working toward your goals while still protecting you to some degree.

When to consider rebalancing the holdings in your portfolio

Rebalancing your portfolio isn’t something you should do all the time, said Roberge. While you want to maintain your general asset allocation, he points out that markets change regularly enough that you don’t want to respond to every move.

Here are five times to consider a portfolio rebalance.

1. Take profits on outperformers

It can be tempting to let your portfolio grow at a fast pace, especially if you see a huge outperformance somewhere. However, Roberge pointed out, when one asset’s value starts overshadowing the rest of the portfolio, there is a chance for devastation when things take a different turn.

“Your portfolio allocation was chosen to help diversify and protect your portfolio while helping you reach your goals,” according to Roberge. “If profits are high in one area, it’s a good time to take those profits and then buy something else that is undervalued.”

Eventually, the asset class will run into a rough patch, and if you’re over-invested in it, you could lose all your recent gains without portfolio rebalancing.

2. Changing financial goals

“Perhaps you had a goal for withdrawing some of your money for 20 years out, but you realize you need some of the money in seven years,” said Roberge. “When you tweak your goals, it makes sense to look at your portfolio and perhaps rebalance.”

Portfolio allocation involves understanding that some assets are better-suited for long-term goals and others might work better for short-term goals. For example, when you know you won’t need the money for more than 20 years, stocks make sense. However, if you need money immediately, having enough of your portfolio in cash is vital.

As your use for the money changes, you might need to change your allocation to reflect better when the money will be used.

3. Major life event

Another reason for a portfolio rebalance is if you’re experiencing a major life event.

“A marriage or divorce can change your financial goals and money use,” said Roberge. “Additionally, if you have a child, you might tweak your portfolio to reflect an interest in saving for college.”

The main life event that often prompts portfolio rebalancing is retirement. As you approach retirement, Roberge pointed out, you start changing your allocation to reflect a need for fixed income rather than growth.

However, even in retirement, it makes sense to continue keeping a portion of your portfolio in stocks to take advantage of continued growth. “It’s important to keep your goals in mind and think of the end result — make sure your allocation is working for you.”

4. Tax purposes

If you can move some of your portfolio into more tax-efficient assets, it can make sense to rebalance. For example, if you sold some outperformers earlier in the year and had large profits, you can offset some of the gains by selling some underperforming assets for a loss. The losses can offset your gains, allowing you to save money in taxes.

Roberge warned that you need to understand where various parts of your portfolio are housed. “Something in a tax-advantaged retirement account isn’t going to do much to help you with taxes because you don’t have to worry about the assets inside the account,” he said. “Know which assets, like those with already-favorable status, should be in a taxable account and which should be in a tax-advantaged account.”

5. Yearly portfolio rebalance

Roberge said that an annual check-in with your overall portfolio makes sense. He suggested scheduling the review for the end of the year so you can use tax-loss harvesting as part of your strategy if it makes sense.

“Looking at things regularly can give you a feel for what’s happening, and help you make changes without overdoing it,” Roberge said.

What are the costs of rebalancing your portfolio?

There are always costs associated with investing and rebalancing. First of all, you’re likely to pay a management fee, no matter where you keep your money, so keep that in mind.

When it comes to the actual costs of a portfolio rebalance, Roberge said you’re likely to see two main expenses:

  • Transaction costs: This is the cost you might be charged to trade within your portfolio, depending on your broker. Some brokers and robo-advisors won’t charge fees, but others might require you to pay a flat transaction cost when you trade. Roberge pointed out that some brokers charge $20 or more to trade individual mutual funds, so it can make sense to focus on no-fee funds and other assets that come with lower costs.
  • Taxes: If you trade in a taxable account, you’ll be subject to paying capital gains taxes when you profit. Roberge said tax-loss harvesting could help reduce the impact, but you still need to take taxes into account when you rebalance your portfolio.

Even with the costs, though, it can be worth it to rebalance your portfolio in a way that keeps it in line with your goals and financial needs.

Rebalance — but not too often

Rebalancing your portfolio can be a good strategy to help you maintain your portfolio and stay on track with your goals. However, said Roberge, it’s important to avoid getting too caught up in changing things. “Don’t try to do it at exactly the right time. That’s more like market timing, and it can get costly.”

Instead, he recommended rebalancing once a year, toward the end. “In early December, see if things are out of line and rebalance if needed,” he suggested. “Then, you can just set it and forget it for another year.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Miranda Marquit
Miranda Marquit |

Miranda Marquit is a writer at MagnifyMoney. You can email Miranda here

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Investing

Pay Off Student Loans or Invest? 6 Questions to Help You Decide

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

piggy bank on a stack of books
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With millions of Americans dealing with more than $1.5 trillion in outstanding student loan debt, it’s no surprise that many young workers are stressed about their debt and hope to pay it off ASAP.

No matter what, it’s vital to keep up with your minimum payments on your student loan debt. But if you can comfortably afford your loan payments along with the rest of your regular budget, what should you do with the spare cash left over at the end of each month? Does it always make sense to pay off your student loan debt immediately, or could you put some of that money to better use by investing?

The decision isn’t always an easy one, but we’re here to help. Here’s what you need to know as you weigh the options.

Pay off student loans or invest: 6 questions to help you decide

Once you have a handle on your monthly expenses and you’re making minimum payments on all your student loans, it’s time to step back and evaluate your situation. If you answer the following questions honestly, you might come to a conclusion about which path — paying off your student loans or investing — is best for you.

1. What are your loans’ interest rates?

Start with your interest rates. How much do your student loans cost, and could you potentially earn more by investing your extra cash?

The common view of paying down debt is that it amounts to a “guaranteed return.” For example, if your student loans have an average interest rate of 4.45%, it’s like earning a 4.45% return on your money since you’re getting rid of something that’s costing you.

However, the average annualized return on the S&P 500 is close to 10%. On top of that, you end up with compound returns from investing, so the earlier you start, the more wealth you can build. By investing today, you could see higher overall returns that beat what you’d save in interest by paying off your student loans faster.

And don’t forget that if you’re eligible for refinancing, you might be able to reduce your student loan interest rates further, see lower payments and put more toward investing, boosting your long-term returns even more.

2. Do you have an emergency fund?

Deciding whether to pay off student loans or invest might not matter if you wind up in an emergency situation and turn to credit cards. Credit card interest rates cost more than you’re likely to earn by investing, and credit card interest isn’t tax-deductible like student loan interest is.

One way to avoid tapping credit cards is to have an emergency fund. You still need to make minimum payments on your student loan debt, of course, but you could divert extra cash toward an emergency fund — building up to at least one to three months’ worth of expenses — before turning your attention to paying off your student loans or investing.

Consider other financial moves that should come before paying down student loans faster too. Paying off higher-interest debt, getting proper insurance and other money priorities might need to be tackled first.

3. Do you earn benefits from your student loans?

Don’t forget that there are some benefits that reduce the overall cost of student loans. Your student loan interest is tax-deductible up to $2,500 if you meet certain income requirements. Plus, because this is an above-the-line deduction, you don’t need to itemize to claim it.

While the deduction isn’t as valuable as a dollar-for-dollar reduction in taxes, it still makes your debt less expensive. That fact, combined with the benefits of investing, means you could see a bigger net gain by investing instead of paying off the debt early.

If you have federal student loans, you may be eligible for student loan forgiveness. If you have a qualifying job and plan to make qualifying payments for Public Service Loan Forgiveness, accelerating your payoff doesn’t help. Additionally, if you qualify for certain forgiveness programs for teachers or health care professionals, diverting spare cash toward investing and taking full advantage of forgiveness may make more sense.

4. Do you have an employer-sponsored retirement plan or employer match?

An employer match is one of the easiest ways to build wealth for the future. It’s free money your company invests for your retirement. Even if you decide that it makes sense to tackle your student loan debt faster, consider investing enough in your 401(k) that you get the full employer match before you divert extra money toward your loans.

There is no substitute for time in the market, and investing while you’re young will benefit you when you’re older. That’s why it typically makes sense to do all you can to earn your employer’s full 401(k) match; otherwise, you’re leaving cash on the table.

5. Does your employer offer student loan repayment assistance?

Find out if your employer offers a student loan repayment benefit, a perk that’s becoming increasingly common. Employers may give you extra cash for your student loans if you can show you’ve been making regular payments.

Make sure you carefully weigh competing benefits, though. If you have to choose between a 401(k) match and student loan repayment assistance, the 401(k) match might be the more valuable option over time.

Some companies, however, help you make the most of both. Pharmaceutical company Abbott, for example, offers a 5% 401(k) match for employees who put at least 2% of their pay toward their student loan debt. It’s a way for you to work toward both goals without sacrificing your future.

6. Does your debt stress you out?

Realistically, the math might not matter as much if your student loan debt stresses you out. High levels of debt can lead to serious mental and physical health consequences. Sometimes, it’s less about the financial aspect and more about the psychological realities of having student loan debt hanging over your head.

Consider your financial and emotional risk tolerance. If you lost your job, would you feel comfortable using an option like deferment or income-driven repayment for your federal student loans? Can you handle your student loan payments with ease while meeting other financial goals? Or does the thought of your debt keep up you at night and tie your stomach in knots?

If your health and well-being are better served by getting rid of the debt, that might be the path to take.

Only you can decide what makes the most sense for your situation. Run the numbers and consider the implications as you decide whether to pay off student loans or invest.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Miranda Marquit
Miranda Marquit |

Miranda Marquit is a writer at MagnifyMoney. You can email Miranda here

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