With the stock market falling throughout much of 2022, investors are rediscovering the risk involved in investing. The unfortunate truth is that your money is always at risk of some sort of loss, whether it's invested or not. As a result, it's critically important to put parts of your money to work in different ways in order to create an end-to-end portfolio that works better for you. You can't eliminate risk entirely, but you can manage it in a way that improves your overall chances for success.
If you want to make your overall portfolio more resilient, you need to put some sort of risk management front and center in your plan. Individually, the investments called out below may not seem like much, but together, these three choices get your overall portfolio that much closer to unstoppable, even in this market.
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No. 1: Cash
It might seem strange to consider cash unstoppable, particularly in an era when inflation keeps running hot. Despite that challenge, cash has one key advantage over other asset classes: It's what you use to pay your bills. On top of that, it's the yardstick against which other assets are measured. As a result, as awful as cash's performance has been when measured against inflation this year, it has far beaten investing in the stock market.
Of course, if cash beats stocks over the long haul, then we all have much bigger things to worry about. As a result, while it's important to have some cash, it's also important to not overdo it. A good guideline is to have enough cash to pay your bills, plus about three to six months' worth of costs in an emergency fund in case you face one of those unfortunate "life happens" moments.
Much more than that, and you'll be at risk of having too much of your money over-exposed to inflation. Much less, and you'll be at greater risk of being forced to sell your stocks while they're down to cover an unexpected expense.
No. 2: High-quality bonds
If you've got bills you expect to pay from your portfolio within the next five or so years, stocks can be an incredibly dangerous place for that money. After all, if the market goes down (like it has in 2022) and you're depending on selling your stocks to cover your bills, then you'll be forced to liquidate that many more shares to cover your costs.
For money you'll need in the near term, bonds have some key advantages over stocks. First, typical bonds have predictable payments -- regular interest payments at published dates, followed by a principal repayment at maturity. That makes bonds far more suitable than stocks for duration matching -- turning an investment into cash just before you need it.
In addition, bond payments take priority over stocks. If a company fails to make a scheduled bond payment, it typically leads to bankruptcy -- and potentially the company's assets being turned over to those bond holders. As a result, if a company can make its bond payments, it is likely that it will make its bond payments.
Still, a company's ability to make its bond payments depends on a combination of its balance sheet strength and its ability to generate cash. So keep an eye out on those, and stick with companies that look capable of continuing to make those payments to improve your chances of your bond investments being truly unstoppable.
Of course, the key downside of bonds is that with generally fixed cash flows and a known lifespan, their total returns are typically limited as well. As a result, while they can often provide better returns than cash for those near-term needs, bonds are not often great long-term wealth-building tools.
No. 3: Broad-based stock index funds
Despite the challenges we are seeing in 2022, there are good reasons to believe that stocks will continue to provide a great vehicle for building wealth over the long term. When it comes to stock investing, over time, low-cost, broad-based stock index funds tend to outperform actively managed mutual funds. That makes broad-based stock index funds an incredibly powerful investment choice for long-term money.
Nevertheless, as 2022 reminds us, the stock market can go down as well as up. That's why stocks -- as unstoppable as they may be over the long haul -- aren't where you want to keep money you need to spend in the near term.
Put them all together for a far stronger portfolio
On their own, cash, bonds, and stocks each have trade-offs and risks that mean they're not really suited to be the only investment vehicle you use. Put them together with an eye toward when you need the money you're saving, however, and they each become foundational elements of a much more unstoppable portfolio.
If you're ready to put the pieces together for yourself, there's no time like the present to get started. Make it a priority today, and accelerate the date that your end-to-end portfolio has a better chance of meeting your needs when you need it to.
