Playing it Safe
August 18, 2010With talk about a possible “double-dip” recession looming, investors had better take precaution. I’m not here to say that I think another recession will occur, but at the same time I don’t think the best approach is to bury your head in the sand and hope that everything turns out okay.
There are several things investors can do to prepare for the possibility of another economic downturn:
1. Diversify, diversify, diversify – Gee, where have we heard that one before? It starts to sound like a broken record, but I cannot stress this enough. I’m a big fan of investing in the stock market, but this should not be the only dog in the race. In addition to US stocks, make sure you have a good amount in international stocks (20%-40% of your stock holdings in non-US companies is generally considered well diversified). Also, now may be the time to consider adding commodities (gold and oil come to mind), fixed income (US and international bonds) and real estate (REITS anyone?)
2. Hedge your bets – Use “stop loss” market orders to limit any potential losses should the markets begin to go south in a hurry.
3. Place your bets – Who says the stock market only pays off when it is going up? You can take a bearish position by shorting certain positions, using options, or investing in bear market funds. The idea here is to make lemonade if the market goes sour. Because of the potential risk associated with some of these strategies, it is best to limit your exposure to less than 20% of your portfolio.
4. Build up your emergency fund – Traditionally, 3 to 6 months of expenses is considered a good amount, but if the economy continues to drag on I’d bump that up to 8 to 12 months, if possible. Now remember, this is emergency money, so don’t get hung up on the fact that you’re only getting 1.5% interest (if that) on this money. Think of this as your bedrock—you don’t want anything to happen to this piece.
While few can agree on whether another recession is about to come, almost all of us can agree the road to recovery is going to be a rocky one. The number one ingredient to successful investing is remaining in the market for long periods of time. While it may be disturbing, Japan went through a similar spell, and it took twenty years before they came out of it. So strap in—it’s going to be a long ride.