Investing in the stock market is an excellent way to generate long-term growth in your retirement portfolio. But to participate in the upside, you’ll have to endure the volatility that goes hand in hand with the stock market.
While the U.S. stock market returns an average of 10% per year over the long run, it regularly experiences drops of 10%, 20% or even more. In your 20s and 30s, you have the time to ride these drops out, but if you’re approaching retirement, they could cause bigger problems.
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Here’s a look at how to protect your IRA from a stock market crash and how your strategy should change as retirement approaches.
Diversify
One of the best ways to protect your assets from a stock market crash is to diversify. Diversification means owning different investments that don’t move in tandem, so that when some of your assets are down in value, others are rising. This can even out the ups and downs that come with a volatile, 100%-stock portfolio.
For a truly diversified portfolio, you should blend a combination of non-correlated assets. If your portfolio is dominated by large-cap tech stocks, like Apple, Microsoft and Nvidia, you should add small- and mid-cap stocks in different sectors, such as healthcare, financials or utilities. If your portfolio is entirely built around U.S. stocks, consider adding foreign stocks, as well.
Beyond the stock world, you can truly add diversification by including other asset classes, such as bonds or precious metals. Overall, you want to build a portfolio that spreads your risk among different types of assets while still meeting your investment objectives.
Keep Some ‘Dry Powder’
Most experts recommend keeping at least a portion of your portfolio in cash or other liquid investments, like short-term Treasuries. This ensures you’ll have reserves that will prove invaluable when the market trades down, allowing you to scoop up shares at bargain levels.
You don’t necessarily need to keep this “dry powder” in your actual IRA account, however. As long as you haven’t already exceeded your IRA’s annual contribution limit, keeping that money in a high-yield savings account, for example, gives you the cash reserves you’ll need to put in your IRA when stocks trade down.
Evaluate Your Risk
Many investors aren’t even aware of how much risk they’re taking in their portfolio. If the Magnificent 7 stocks are all that you’ve owned for the last few years, for example, you likely feel pretty good with yourself, as those stocks have all skyrocketed to some degree.
But in the stock market, high reward equates to high risk. Stocks that rise by 50% or 100% in a single year may still prove to be great long-term investments, but you shouldn’t be surprised to see them sell off by 25%, 50% or even more at some point.
If you’re about to retire and all of your stocks are these high-flyers, you’re very exposed to a potential stock market crash. Evaluate how much risk you can really handle and adjust your portfolio appropriately. If your portfolio is tech-heavy and crashes 50% right when you begin retirement, you’ll be off to a rough start that could impact your quality of life for decades to come.
Rebalance
You can help reduce the risk in your IRA by rebalancing your portfolio regularly. Ideally, when you initially built your portfolio, you set up a diversified account in line with your investment objectives and risk tolerance. When one segment of your portfolio outperforms over a period of time, it will no longer be in line with your pre-planned investment strategy. This typically introduces excess risk into your account.
As a simple example, imagine that you constructed a portfolio that allocated 30% of your assets to large-cap tech stocks, 30% to an S&P 500 index fund and 40% to bonds. Over the last few years, it’s likely that those percentages would now look something like 40% in tech stocks, 35% in the S&P 500 and just 25% in bonds. This leaves you overexposed to a market crash.
By rebalancing now, back to your original strategy, you’ll be better protected.
Note that an asset allocation should never be a “one-and-done” strategy. As you age and as your investment needs change, so, too, should your allocation change. If you’re approaching retirement, for example, you should generally court much less risk in your account than if you were a 25-year-old.
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This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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