As the coronavirus pandemic sent markets reeling, many investors wonder if there's such a thing as a safe investment. Technically, no investment is risk-free. But some investment practices can be safer than others.
In just five weeks from mid-February to mid-March 2020, the “COVID-19 crash” really did a number on the markets. The S&P 500 tanked around 35%, the Dow Jones plunged 38%, and the Nasdaq took a 40% dive. Although the markets have mostly recouped in the short term, there are big question marks going forward. The pandemic’s longer-term effects on the global economy still remain uncertain as negative data continues to pour in. Unsurprisingly, many investors are seeking “safer havens” outside of equities during this period of heightened volatility.
Granted, there are ways to invest in a bear market or rebalance a portfolio when the sky appears to be falling. Bonds and fixed income are also among investors’ preferred safety assets. But let’s not get ahead of ourselves and overlook something critical: When it comes to investing in uncertain times, how you invest may be just as important as what you invest in.
In other words, how you allocate your assets, diversify your portfolio, and manage your risks can sometimes be more important than the assets you choose (safe haven or not). Safe investment practices can help you convert an inherently risky endeavor into a smart and relatively safer opportunity.
An advice columnist used to say, “Want to double your money quick? Fold it in half and put it in your pocket.” This assumes that cash is the safest investment to hold, as it presents no possibility of loss. But is that true?
If you check any inflation calculator, you’ll see how the purchasing power of cash generally erodes over time. That’s loss. It’s barely perceptible but ever present and perpetual. Plus, with cash under the mattress and not in the market, you might rob yourself of the opportunity to generate potentially strong growth once the next bull cycle begins. Cash may be relatively safe, but it’s by no means risk-free. Cash has buying power, but unless you put it to use in pursuit of growth, you can’t really call it an investment.
The familiar saying “no pain, no gain” could be adapted for investing as “no risk, no return.” Still, that’s more than a little vague. And when market volatility causes circuit breakers to kick in on a seemingly regular basis, as we saw during the 2020 selloff, it’s a saying we’d rather forget. So, here’s a clearer way to view risk and return:
In other words, it’s no easy feat to find low-risk investments with high returns. There’s typically a trade-off. This invites the next question: What investing practices can minimize your risks while maximizing your potential returns?
When you see a potential market storm on the horizon, it often helps to fall back on a few simple and practical rules.
1. Allocate Your Assets Strategically
Asset allocation refers to the percentages of your total portfolio holdings that you place into stocks, bonds, and cash. Sound simple? In principle, yes. In practice, however, apportioning your assets to match your investing goals, risk tolerance, and time horizon requires time, thought, and effort. Asset allocation may be the most fundamental, strategic, and perhaps important part of your investing process.
So allocate your assets carefully. You’re laying the foundation for every other investment decision you subsequently make.
2. Don’t Put All Your Eggs in One Basket
In a nutshell, this is what diversification is all about. When the market turns down, the various parts that make up the broader market—from industries and sectors to individual companies—may react differently. Some may experience sharp declines, while others may not decline at all or may even rise. This points to the idea that various individual components of the broader market may behave differently in relation to one another depending on market conditions.
Diversification is about selecting assets that won’t all move in the same direction when negative market conditions occur. It means spreading your risk across different types of assets. Avoiding the infamous risk of placing all of your eggs in one basket. The assets you select—whether stocks or bonds—may move in different directions when exposed to factors that negatively affect the broader market.
3. Consider Seeking Protection
Some investors take the “eggs-and-baskets” thing a step further and seek portfolio protection. Two common vehicles are put options and index futures. Put options might be targeted for individual stocks. Or, when seeking to hedge a broad-based portfolio, investors may consider put options on indices such as the S&P 500 or the Nasdaq-100.
Granted, these are advanced strategies for advanced investors, and they’re not for everyone. But if you’re interested in learning about put hedges or how some professional investors and traders use futures as a counterweight during times of market stress, education is key. Fortunately for TD Ameritrade clients, investor education—from articles and videos to fully immersive courses that can walk you through the steps—is freely accessible.
4. Plan for the Long Term
We’ve all heard that a passive buy-and-hold strategy may be more fruitful than a more active market-timing approach. The truth is, there’s no way to definitively prove which approach is more successful or risky. It all depends on the investor and the circumstances. But we can look at how the broader stock market has performed over time, and we can ask, “What might have happened if I had bought and held stocks in the broader market?”
If we define a bear market as a decline of at least 20%, then according to CFRA data on the S&P 500, we’ve had roughly 12 bear markets from the 1940s to the present. During this period, bear markets averaged a loss of around 33%, while bull markets rose an average of 165%. In short, if you continually held S&P 500 stocks at any point from the 1940s until now, you might be ahead despite any of the historical downturns. Of course, there’s no guarantee that will hold true in the future.
When it comes to lower-risk investment practices, these four ideas are just the tip of the iceberg. But hopefully they demonstrate that although seeking “safe investments” can be a futile quest, “lower-risk investment practices” can be a sensible pursuit. Educated and well-informed investors can consider risk-adjusted return, diversification, and a long-term investment horizon to fine-tune their risk management.
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