The S&P 500 has risen more than 25% this year, but with the threat of interest rate increases next year and supply chain issues causing problems for many companies of late, it's understandable if you're worried about the possibility of a market crash in the near future. The challenge is that it can come without warning, and catch investors flatfooted.
However, you can take steps to hedge and minimize your risk. Here are three things you can do if you're worried about the stock market.
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1. Hold a little more cash
One thing to consider is simply pulling some money out of the stock market. If you have some investments that have generated great returns for your portfolio but you aren't sure how safe they will be in the future, it may be a good idea to realize those profits sooner rather than later depending on your stage of live. And even if you aren't sitting on a large profit, liquidating some of your riskier investments can make your portfolio safer overall.
You wouldn't be alone in doing this, as Warren Buffett is sitting on a record $149.2 billion of cash on hand. He isn't loading up on stocks, and instead is remaining cautious. Cash provides investors flexibility. If interest rates go up, they can put it into savings accounts or bonds. If the market crashes, they can use it to buy stocks at cheaper prices.
How much you decide to hold in cash will ultimately depend on your prsonal strategy and risk tolerance.
2. Stick to value stocks with strong fundamentals
For the money that you do have in stocks, consider focusing on value investments. These are stocks that don't trade at obscene multiples and that have strong fundamentals.
A good example of this is pharmacy retailer CVS Health (CVS -1.62%). Although the company's margins aren't huge, CVS has reported operating profits of around 5% of revenue over the past five years. After its $69 billion acquisition of health insurance company Aetna in 2018, CVS has also become more diverse, which could lead to better margins and long-term stability. Its stores are focusing more on offering healthcare services and being more than just your regular pharmacy. The company plans to have 1,500 HealthHub locations (which feature in-person classes and more personalized care) open by the end of this year.
The healthcare stock trades at a price-to-earnings (P/E) ratio of 16, which is cheap given that the average holding in the Health Care Select Sector SPDR Fund trades at 27 times its profits. In addition, CVS pays investors a dividend yield of 2.2%, which is better than the S&P 500 average of 1.4%.
With a safe and profitable business, a recurring payout, and a decent valuation, CVS is the type of stock that can provide some safety for investors in the event of a crash. While it may not be immune from a correction, it will be less vulnerable than more egregiously priced investments.
3. Invest in the new anti-ARK ETF
The last option on this list is a bit more aggressive. It involves betting against high-priced growth stocks, specifically those that are in Cathie Wood's ARK Innovation ETF (ARKK 2.98%). The Tuttle Capital Short Innovation ETF (SARK -2.89%), which just launched this month, aims to produce the inverse return of the ARK ETF. The fund describes itself as a "short vehicle" that regular investors may have difficulty setting up for themselves.
In essence, investing in the Short Innovation ETF is to bet against the ARK Innovation ETF. While I wouldn't normally short shares of a stock, investing in an ETF like this takes some of that risk away. There are no margin calls involved and investors can treat this as a normal holding in their portfolio.
A big reason why investors may want to consider betting against the ARK ETF is that many of its top holdings are incredibly expensive. Electric car maker Tesla is a staple of the ARK ETF, and the stock trades at a whopping 367 times its earnings. Fintech company Square is a bit cheaper, but investors are still paying 210 times earnings for that stock.
The ARK Innovation ETF is down 9% this year as investors have been gravitating away from high-priced growth stocks. And in a market crash, many of the stocks in the ARK fund could collapse, which is why taking a short position could be a way to hedge against the stock market's hefty valuations.
