Nervous about a stock market crash? 3 ways to protect your portfolio

The markets are in correction territory with the S&P 500 15% lower and the Nasdaq composite at the time of writing down by 23% to date. And many Americans worry that the worst is ahead, a new poll by Allianz life insurance.

The recently published quarterly Market Perceptions Study found that only 47% of respondents believe the economy will improve in 2022, up from 54% in the previous quarter, and 60% fear a recession.

In the markets, 56% of respondents are concerned about another “big market crash” — up from 50% last quarter — while 81% expect volatility to continue throughout the year. Perhaps the most surprising statistic from the survey is that 43% said they are too nervous to invest in the market right now, up from 34% last quarter. This is the highest percentage since 2019, according to Allianz. In addition, 66% wished they had taken their profits at market heights.

Those investors who are still in the market are looking for safety, the Allianz survey shows. Specifically, 59% of respondents are looking for ways to add more protection to their portfolios. Here are three easy ways to protect your portfolio from everything the market has to offer.

A person at their kitchen table, hand to face, looking nervous.

Image source: Getty Images.

1. Diversify, don’t stand still

When the market collapses, as it has for the past six months, the reflex response is to constantly check your portfolio — I just did it this morning. But try to avoid this, because ultimately your focus should be on the long term. Responding to short-term volatility can lead to hasty decisions that hurt your long-term performance.

A better approach is to review your portfolio with a strategic eye and ensure it is built to withstand the volatility and generate solid returns that meet your goals.

A good way to do this is to varied portfolio with stocks performing differently in different market cycles. While some of your technology and growth stocks have fallen an obscene amount, some stocks in other sectors, or value stocks, may be doing well. For example, at the time of writing, the S&P 500 is up 1% in the past 12 months, while the small-cap Russell 2000 has fallen almost 16%. In terms of growth versus value, the Russell 1000 value index is up about 1% in the past year, while the Russell 2000 growth index has fallen by 24%.

You can also look at sectors. This year, shares in the energy sector have risen significantly, while communications services and information technology are down 15% or more.

Learn how different market segments perform in a given market cycle. And if you’re not sure about the best bets in a particular segment, there are thousands exchange traded funds (ETFs) that can give you a diversified basket of stocks in a particular industry or investment style.

2. Review your assignment

If the wild swings in the market are alarming, you can also dampen that volatility by adding bonds to your portfolio. Fidelity Investments recently analyzed the returns during the market crash from 2008 to 2009 for two different types of portfolios: one with 100% stocks and one with 70% stocks and 30% bonds. The all-equity portfolio fell about 50% from January 2008 to the market low in February 2009, while the diversified portfolio fell by about half.

If you look at the performance between January 2008 and February 2014 — through the crash and the recovery — both portfolios had about the same performance. This tells you a few things. First, the diversified portfolio offered a smoother ride and still delivered the same returns as the all-stock portfolio. Second, the equity portfolio eventually recovered from the sharp downturn and accelerated growth from the bear market. If you had sold to the bottom, you would not have benefited from that recovery. And three: patience is rewarded.

In addition, a study by Vanguard looked at the average annual returns of various portfolios from 1926 through 2020 and found the average annual return for a balanced 50/50 portfolio of stocks and bonds over that period to be 8.7%. The best year saw returns of 34%, while the worst year fell 23%, with 20 of the 95 years having negative returns. An aggressive portfolio of 80/20 stocks versus bonds had an average annual return of 9.8%, with the best year up 45% and the worst down 35%. However, 24 of the 95 years were negative.

A portfolio composed of 80% bonds and 20% equities had an average annual return of 7.2%. In the best year there was a return of 41% and in the worst year a decline of 10%. Only 16 of the 95 years ended up in negative territory.

3. Dividends are your friend

Dividend stocks pay investors a quarterly (sometimes monthly) cash distribution from their earnings. So no matter how well the stock price does, dividend stocks will you pay every quarter† Dividend stocks are typically large, established companies with a history of solid profits. About 84% of the shares of the S&P 500 pay dividends.

This is why dividend stocks are important during down markets. First, as mentioned, you get the quarterly income if you choose not to reinvest it. Two, if you reinvest the dividend, it will help increase your total return. Fidelity recently conducted a study that found that since 1930, dividends have made up 40% of the S&P 500’s return. But during bear markets, they add much more to the total return. For example, in the 1970s, dividends accounted for 71% of the S&P 500’s total return. By comparison, during the 2010 bull market, they only accounted for 16% of the return.

These are troubling times, but patience and a solid strategy can help you navigate a stock market correction.

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