By Anthony Davidow, Charles Schwab & Co.
Given the recent uptick in market volatility, it may be time to think about playing a little defense.
Of course, a portfolio strategy that employs both offensive and defensive assets is prudent no matter the prevailing market conditions. For proof positive, look no further than the Great Recession, during which investors in traditionally defensive assets — including cash investments, precious metals and U.S. Treasuries — generally saw positive returns, even as their domestic and international stock investments plummeted.
Here are four asset classes that can help stabilize your portfolio during a market correction — and Schwab’s general guidance regarding your exposure to each.
1. Cash and cash equivalents
Why: Putting a chunk of your portfolio in money market funds or certificates of deposit (CDs) won’t generate much in the way of interest, but these products do offer liquidity in case of emergency, flexibility as new investment opportunities arise and stability relative to other asset classes.
What’s more, CDs are insured by the Federal Deposit Insurance Corporation (up to $250,000 per depositor), so you won’t lose your money even if the issuing bank fails.
How much: Generally speaking, even the most aggressive investors should hold at least 5% of their portfolios in cash and cash equivalents; for conservative investors, that allocation may be closer to 30%.
2. Gold and other precious metals
Why: Because of its finite supply, gold tends to maintain its value even during periods of economic upheaval. Other precious metals may also hold up well, though that can depend in part on what they’re used for. (Platinum, for instance, is used in the catalytic converters found in many automobiles, whose sales tend to rise and fall with the broader economy.)
Even during a bull market, the prices of precious metals tend to move independently of stocks, enhancing any potential diversification benefits. And because their prices tend to rise along with inflation, they may also provide a hedge against broad cost increases. That said, precious metals’ prices can be affected by world events, import controls, and other external risks; they also tend to be more volatile than those of other defensive assets, which may make them unsuitable for risk-averse investors.
How much: Precious metals, together with other commodities and real estate, should account for as much as 9% of an aggressive portfolio; less aggressive investors may want to limit such exposure to 5%, while the most conservative investors may want to avoid the asset class entirely.
3. U.S. government-related bonds
Why: These securities are issued by government-owned corporations (GOCs), such as Amtrak, and government-sponsored enterprises (GSEs), such as the Federal Home Loan Mortgage Corporation, otherwise known as Freddie Mac. Unlike federal agency bonds, which are backed by the full faith and credit of the U.S. government, GOC and GSE bonds are the sole responsibility of the issuer, meaning the federal government is under no obligation to save them from default. This can make these bonds riskier than Treasuries, and investors are offered incrementally higher yields as a result.
Like Treasuries, agency bonds’ prices fluctuate in response to interest rates, which could affect their price on the secondary market. Furthermore, many agency bonds are callable, meaning the issuer may choose to pay back the principal before the maturity date, thereby cutting coupon payments short.
How much: U.S. government-related bonds, together with Treasuries (see below), should make up anywhere from 10% to 70% of your portfolio, depending on your risk tolerance. However, the most aggressive investors may want to avoid such exposure altogether.
4. U.S. Treasury bonds
Why: Treasuries are backed by the full faith and credit of the U.S. government, making them one of the most stable investments for protecting capital. Intermediate-term Treasuries (those with maturities of 3 to 10 years) have held up particularly well during downturns, registering positive total returns during all but one of the 28 bear markets since 1929.
Should the Federal Reserve continue to push rates higher, Treasury prices on the secondary market may decline. That’s likely of little concern to investors who plan to hold their Treasuries to maturity but is a risk nonetheless.
How much: See “U.S. government-related bonds,” above.
Finding your mix
Ultimately, your exposure to each of these asset classes should depend upon your personal risk tolerance, time horizon, and market outlook.
Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on nearly $475 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.
Additional Important Disclosures
Past performance is no guarantee of future results. An investment in a money market fund is not a bank deposit and is neither insured nor guaranteed by the FDIC or any other governmental agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in these funds. Investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost. Certificates of deposit are issued by various FDIC-insured institutions, and are subject to change and system access. Unlike mutual funds, certificates of deposit offer a fixed rate of return and are FDIC-insured. There may be costs associated with early redemption and possible market value adjustment. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk. Commodity‐related products carry a high level of risk and are not suitable for all investors. Commodity‐related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc. Indexes are unmanaged, do not incur management fees, cost or expenses, and cannot be invested in directly. The Bloomberg Barclays U.S. 10 Year Treasury Bond Index measures the performance of U.S. Treasury securities that have a remaining maturity of 10 years, are rated investment grade and have $250 million or more of outstanding face value. The Bloomberg Barclays U.S. Agency Bond Index measures the performance of the agency sector of the U.S. government bond market and is composed of investment-grade native-currency U.S. Dollar-denominated debentures issued by government and government-related agencies, including the Federal National Mortgage Association (“Fannie-Mae”). The Bloomberg Barclays U.S. Short Treasury Index includes aged U.S. Treasury bills, notes and bonds with a remaining maturity from 1 up to (but not including) 12 months. It excludes zero coupon strips. The MSCI EAFE Index captures large- and mid-cap representation across developed markets countries around the world, excluding the U.S. and Canada. The index covers approximately 85% of the free float-adjusted market capitalization in each country. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging markets countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country. The S&P GSCI Gold Index is a sub-index of the S&P GSCI. It is comprised of 24 raw materials from all commodity sectors and serves as a measure of commodity performance over time. The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index, representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities, based on a combination of their market cap and current index membership. The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.