Open your computer or smartphone these days and the stock market warnings fly by in giant type — “Summer Crash Imminent” and “Sharp Correction Ahead” blink at the top of nearly every investing website.
Leave aside for the moment that many of these same pundits have predicted a crash each and every month for several years now, and the simple fact that absolutely nobody can time the market with anything resembling consistency.
Instead, let’s assume that for once they are right. Stocks must go down at some point in the relatively near term. Maybe by the middle of July, maybe August. Assume the doom-and-gloom crowd gets it right this time, after so many misses.
What can you really do about it? Well, they have plenty of ideas for you. Mostly, it involves hiding under a rock, starting now, or setting up some fairly sophisticated defensive trades.
The “hide under a rock” method isn’t hard to grasp. They would have you sell all of your stocks and just put it all in cash. Not the bond market, since everyone apparently is certain that bonds will crash soon, too. Just cash in a bank account or a money market, earning nearly zero.
Essentially, they contend that you’re better off losing purchasing power to inflation than taking any kind of risk in either stocks or bonds. OK, simple enough.
The fancy-trade method come in various flavors. You could try options trading. Or buy leveraged inverse funds that go up when stocks go down. Or short the entire stock market.
Or, possibly, you could just prune your stock portfolio selectively, selling only those companies that seem the most overvalued. It’s less clear how you would know this any better than an entire stock market full of investors and thousands of Wall Street analysts, but that’s the advice.
So here’s the real way to do it, the way it is done by pension managers and college endowments:
1. Own a diversified portfolio
If you are holding a well-designed portfolio of index funds — one that contains stocks, bonds, real estate, foreign equities and foreign debt — stocks never feel like “too much” of your portfolio. It’s just one piece of a larger puzzle.
2. Rebalance it periodically
If you rebalance correctly you’ve been selling stocks steadily all through the year, year in an year out, as they have gone up. The money was then reinvested, also steadily, into parts of your portfolio that were relatively cheaper.
3. Sell high and buy low
Over the past few years, rebalancing meant you were selling off U.S. stocks to buy foreign equities. In the past few months, in fact, foreign stocks have “woken up” and now are getting hot. A serious portfolio manager got into foreign equities in steady, measured buys when they were cheap. He or she will get back out of them in the same steady, measured way.
4. Keep costs low
You can rebalance a small, undiversified portfolio. Same with a collection of expensive, actively managed mutual funds. But why pay the freight for an uninspiring return filled with unnecessary risk-taking? Just use index funds or index-style exchange-traded funds.
The simple fact is that owning a portfolio and indexing removes all the pressure from being an investor and creates opportunities, over and over, to reinvest real gains. No tricky options trades, no leverage, low cost, easy to sleep at night. If you do this repeatedly, year in and year out, it’s very difficult not to earn a great annualized return at minimal risk and cost.
And there’s no real need to panic when you see things on the Internet. If you open your computer in the morning and feel bad about your investments and the risk of a summer stock market crash, that’s just a sign that a change in your approach is past due.