Most Americans are making a big mistake with their investments. According to a recent study from TIAA, just 39% of Americans believe their investments are well protected from stock market downturns and volatility. This figure is shocking, especially in light of the fact the survey was taken during the bumpy ride the market has been on since March.
When the coronavirus first arrived in full force in the U.S., retirement and other household accounts lost $14.2 trillion in value. While the market rally over the following months erased virtually all of those losses, this recovery was an unusually quick one. The fact that 61% of Americans lived through this market turbulence so recently and still haven't taken steps to protect themselves from downturns suggests a key financial lesson wasn't learned.
The reality is that market crashes can come on suddenly, they will eventually happen, and you need to be prepared for them. And it doesn't take a global pandemic for the market to experience a sudden crash. In fact, market corrections and recoveries are a natural part of economic cycles. While those who started investing in the 2010s have seen a decade of unusual stability, if you're banking on this continuing indefinitely, you're putting your portfolio at serious risk.
The good news is that it's not difficult to make sure your investments are protected against a volatile market. In fact, there are just four simple steps you need to take if you don't want to bet your nest egg on an unlikely future without market volatility.
1. Don't invest money you'll need within five years
Over the long haul, the market always recovers from crashes. But the long haul is a lot longer than five years. If you invest money you'll need in such a short time, there's a very real chance you could end up having to sell during a prolonged bear market, and you could face outsized losses because of it. You don't want to put yourself in a position where you lock in investment losses, so keep your money out of the market unless you won't need it for a while.
2. Invest in companies you'd be happy holding for the long-term
One of the surest ways to risk your portfolio in the event of a downturn is to buy stocks hoping to make a quick buck. If you do this at the wrong time, you could get stuck either selling your stock at a loss or holding your shares through a prolonged downturn, even if you don't believe in the company's staying power during tough economic times.
Warren Buffett famously said that you shouldn't hold a stock for 10 minutes if you wouldn't feel comfortable holding it for 10 years. That's a good guideline to live by if you want your portfolio to be well protected from market volatility.
3. Maintain an appropriate asset allocation
Investing money you'll need soon, or making short-term investments, aren't the only two big risks that could lead to devastating losses if your portfolio isn't protected against volatility. You could also find yourself facing problems if you're over-invested in the stock market.
The bottom line is that, while you need to be invested in equities to earn reasonable returns and build wealth, you do take on a greater risk by buying stocks. You can afford to take that risk when you're young and have lots of time left to build your nest egg back up in the event of a disaster. But as you get older, you need to move more of your money into safer investments, even if they could produce smaller returns.
When investing for retirement, one easy way to determine your ideal asset allocation is to subtract your current age from 110 and put the resulting percentage of money into the stock market.
4. Build a diversified portfolio
Finally, the money you do invest should be spread across a diverse array of different companies across different industries. That way, if some sectors of the economy are hit especially hard during bad times, you'll hopefully have investments in others that perform well. You can build a diversified portfolio by buying individual stocks, but if you'd prefer a fast and simple approach, ETFs that track broad market indexes, such as the S&P 500, could be your better bet.
If you don't invest money you'll need soon, you invest for the long-term, you don't put too much of your money into the stock market, and you make sure you have shares of many different kinds of companies in your portfolio, you should be able to join the minority of Americans who feel confident their portfolios can withstand volatility, or even another downturn.