Worried about a market bubble? Here are 4 tips to protect your portfolio now and in the future
You may have heard the stock market is up a lot over the last year or so, and the housing market is, too. Cryptocurrencies have been surging — at least until recently.
The economy is booming back to life after a year of pandemic-induced lockdowns and most assets are booming right along with it. But you pay a high price for a positive outlook in investing and value-minded buyers may be struggling to find bargains amid today’s high prices.
So what can you do if these lofty prices make you squirm? Below are some tips on what to do when nearly everything has already gone up and it’s feeling kind of frothy out there.
1. Avoid the craziness
What you don’t own can be just as important as what you do. A good first step to avoid getting hurt in an overheated market is to make sure you steer clear of the hottest areas. Recently, that has meant avoiding the so-called meme stocks like AMC Entertainment, GameStop and Bed Bath & Beyond. The huge price swings get a lot of attention in the short term, but in most cases their underlying businesses face severe challenges and may have a hard time earning enough for shareholders to justify their current valuations.
Instead, make sure the stocks — or stock funds — in your portfolio are composed of profitable companies that are likely to continue growing over time. Remember that stocks aren’t just prices that flash on a screen, but represent real ownership interests in a business. Stock prices should follow the performance of the business over time.
2. Embrace boring
It’s also a good time to make sure you’re taking care of the basics. Look at your 401(k) or other workplace retirement plan and make sure you’re contributing enough to receive the maximum match your employer offers, and that the funds are being invested in simple index funds that don’t have too much exposure to the market’s high flyers.
There are many trendy investments that have generated outsized returns over the past few years, such as Tesla and Zillow. These companies may generate abundant profits for shareholders some day in the future, but with their lofty valuations you will likely find others that offer more of a bargain today.
Consider steady growers with solid dividend yields and reasonable valuations instead. Companies like this aren’t likely to double or triple in the near term, but should deliver attractive long-term returns compared with many of the hot stocks of 2021 whose underlying businesses generate little to no profit or are even currently losing money.
Think about investing in ETFs or mutual funds that own companies with consistent dividend payouts over the years instead of chasing the hottest names of the month in the crypto space or the latest tech IPO.
3. Don’t reach for yield
Savers and investors who rely on income from their investment portfolios are no doubt aware of the paltry returns currently offered by most fixed-income investments. Just 10 years ago, the U.S. 10-year treasury bond yielded about 3 percent, Five years prior to that, it offered more than 5 percent. While not much, that yield helped generate income for savers and retirees alike, while today the same bond only offers around 1.5 percent. These record-low rates cause some to look elsewhere to generate income, but investors need to be careful not to chase higher returns and unknowingly assume more risk.
Risky corporate debt, or junk bonds, can be a popular place to look for a yield boost when government rates are low, but the bonds are typically issued by companies in poor financial health and may be at risk of missing interest payments. Remember, they are called junk bonds for a reason. Their prices would also decline if interest rates were to rise to more normal levels.
If your returns have been hit by low interest rates, resist the urge to seek additional yield in riskier investments. It’s better to adjust your spending habits to the low-rate environment than it is to risk a permanent capital loss by reaching for yield.
4. Consider holding some cash in your portfolio
Most people agree that cash is a lousy long-term investment. It’s virtually certain that it will lose value over time, but one thing it can add to your portfolio is optionality. If you think most of the investment opportunities today are unattractive, cash gives you the option to pounce quickly on opportunities in the future, though when those might come is always unclear.
To be sure, holding cash can be psychologically difficult, particularly in speculative environments when everything seems to be going higher. It doesn’t feel good to have cash just sitting there earning next to nothing. But when the emotions of the market inevitably swing in a more fearful direction, holding some cash today could end up proving to be valuable.
If you’re concerned about today’s lofty valuations, consider holding 5-10 percent of your portfolio in cash and cash equivalents — it’s one of the most contrarian investments you can make.
Bottom line
Nearly every financial asset has increased substantially over the past year, leaving valuations high and future return expectations low. Make sure you’re limiting your exposure to the most speculative areas of the market like meme stocks and cryptocurrencies.
Consider holding a portion of your portfolio in a highly liquid investment — like a money market fund — to be better positioned for future opportunities. Make sure you’re taking care of the basics and consistently contributing to a workplace retirement plan like a 401(k). Remember that slow and steady typically wins the investing race.
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