When the stock market is strong, there's never any shortage of solid investment ideas to preserve and grow your wealth. But when volatility hits, it suddenly gets a lot harder to find profitable investments for your portfolio, and often, the strategies that worked so well in past downturns turn out to be exactly the wrong investment ideas to follow.
The stock market has gotten a lot more volatile in recent weeks, but so far, we haven't seen any sizable decline from its record highs. Yet many investors are looking to lock in their big profits from the past four years, and they're making moves that have historically worked well to minimize losses. Unfortunately, there's good reason to believe that some of those moves aren't as safe as they may appear. Let's look at three investment ideas for falling markets that might not work as well in the next downturn.
1. Low-volatility stocks are always safe.
Low-volatility stock investing has only gained notoriety in the past couple of years, but most investors have followed a less analytical variant of the strategy for decades. Essentially, what following a low-volatility investment strategy entails is choosing stocks that tend not to move as sharply on a percentage basis as the overall market. Such stocks tend to underperform during big bull-market runs, as riskier high-growth companies take greater advantage of the good times to produce rising profits that lead to higher stock prices. But when the economy turns south, those companies -- many of which are in industries that investors see as defensively oriented, such as consumer goods -- tend not to drop as much.
Yet any investment is subject to danger when it gets too popular, and that's arguably been the case for low-volatility stocks lately. Just in a single week, low-volatility stocks Procter & Gamble (NYSE:PG) and Verizon (NYSE:VZ) suffered big losses of around 5%, compared to just a 3% loss for the broader market. Both stocks have been go-to ideas for investors seeking safety, and as a result, their valuations have gotten extremely high on an earnings-multiple basis. Moreover, P&G has had to deal with challenges from competitors that have threatened its historical edge in innovation, and Verizon finds itself increasingly distracted by the fact that it only owns 55% of its lucrative Verizon Wireless joint venture.
2. Bonds will always move in the opposite direction of stocks.
For many investors, the knee-jerk reaction when stocks fall is to buy bonds. When the stock market is starting to fall because high interest rates have begun to stifle economic growth, that strategy works extremely well.
But since the financial crisis ended, the stock market has managed to rise even as bonds have continued their 30-year bull market. Similarly, there's no guarantee that stocks and bonds won't drop in concert as well. Already, we've seen major drops in iShares Barclays TIPS Bond (NYSEMKT:TIP) and foreign SPDR Barclays International Treasury Bond (NYSEMKT:BWX), and further losses are possible if uncertainty about the Federal Reserve's next actions doesn't get resolved in the near future.
3. Dividend stocks are safer than other stocks.
Like low-volatility stocks, dividend stocks have been seen as a panacea for income-seeking investors. When bond rates hit record lows, investors moved in droves to dividend stocks to replace lost income.
The income that dividend stocks produce does help ameliorate the negative impacts of downward-moving markets. But the fervor with which investors have bought dividend stocks has made them more vulnerable than usual to falling stock prices. Moreover, some high-profile stocks that have cut their dividends lately serve as a reminder that you can't absolutely count on stocks to deliver on their promises of high income and safety.
Watch your back
Many investors erroneously believe that these three investment ideas will help protect their portfolios from a future downturn. That's possible, but it's also possible that they'll fail miserably under the weight of too many people counting on their being true. Be sure to watch your portfolio carefully to make sure you're not relying on investment ideas that won't hold up to the next high-stress situation for the market.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.