How to protect your investments in turbulent times

How to Protect Your Investments in Turbulent Times

In times of market turmoil and economic uncertainty, it's crucial for investors to have a clear strategy. This article provides tips and insights on how to best navigate these challenges.

1. Market analysis and long-term perspective

Current situation:

On August 5, 2024, the markets faced a wave of sell-offs and significantly increased volatility. What led to this sell-off? Here are some causes:

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• US data (SAHM rule): Unemployment has risen, which may indicate an impending recession. The SAHM rule states that if the three-month moving average of unemployment is 0.5% higher than the lowest point in the past 12 months, a recession is likely. However, Claudia Sahm, the creator of this rule, advises caution as the job market has been disrupted by COVID-19.
• Japanese yen (JPY) carry trade unwind: Investors are halting the practice of borrowing cheap yen to invest in other currencies, especially in technology and AI, due to uncertain returns on these investments, leading to a retreat from these trades.
• Decline in Trump's chances: The decreased likelihood of Trump winning the election has brought uncertainty to the market.
• Quarterly results from Amazon and Intel: Last week’s quarterly results significantly impacted the market as they did not meet the very high expectations.
• Buffett's sell-off: Warren Buffett, known for his "buy low, sell high" strategy, has recently sold half of his Apple shares. His selling can be a signal that markets are high and future gains are uncertain.

The Federal Reserve may reduce interest rates by 0.25% in September. A larger reduction would only be logical if something significant happens, such as a major economic disruption or financial crisis.

Future outlook:

Markets always recover, even though it may take time. Investors should keep their long-term goals in mind. Patience is key; although recovery may take time, markets will eventually rise again.

2. Investor confidence despite volatility

Rational investor behavior:

Experienced investors remain calm during turbulent times and take advantage of opportunities that arise. Despite the turmoil, they remain active in the market and continue buying stocks because they believe that markets will recover in the long run and that declines present good buying opportunities. However, this is certainly not implying that this is a good moment for dip-buying, as there is still too much uncertainty in the markets, evidenced by the volatility indicators remaining very elevated.

3. Portfolio protection and risk management

Diversification:

One of the key strategies to limit risks is diversification. By spreading your investments across different types of stocks, sectors, and countries, you can reduce the risk of losing everything if one investment performs poorly. Additionally, it's wise to use various investment instruments such as stocks, bonds, and ETFs (exchange-traded funds).

Diversification helps not only to spread risk but also to increase the chance of returns. For instance, if the stock market performs poorly, bonds or other investment instruments might perform better and offset losses in stocks. It is also important to diversify within each asset class. This means not only having different types of stocks but also different sectors and geographic regions. This can help reduce the impact of negative events in one specific sector or region.

Hedging:

Investors can also use options and other instruments to protect their portfolios from further declines. This can be complex, so it’s important to educate yourself and seek information on these strategies.

What to do?

Investors have two possible approaches in this situation:

1. Panic and sell:
   • Fear of a recession in the US could lead to more selling, which would be bad for US stocks. This can further destabilize the market and potentially lead to greater losses.
2. Approach the situation strategically:
   • SAHM rule: Although this rule predicts a recession, Claudia Sahm herself advises caution as the job market is disrupted by COVID-19. The job market is cooling down mainly due to fewer hires and more people looking for jobs, not mass layoffs.
   • Healthy earnings growth: Despite concerns about AI spending and corrections in tech stocks, there is broad growth in US stocks, including the 'lagging' sectors. AI remains a significant trend, and investments in it are aimed at future growth.

How to act in difficult market conditions

In challenging market situations, such as crashes and/or severe market corrections, it’s important to follow a thoughtful and strategic approach to protect your investments and potentially take advantage of opportunities. Here are some key steps:

• Stay calm and avoid panic selling: Emotional reactions can lead to hasty decisions. Avoid panic selling, as markets often recover over time.
• Rebalance and adjust your portfolio: Check if your portfolio still aligns with your long-term goals and risk tolerance. Rebalancing means adjusting your investments to maintain your desired mix of investments. For example, if stocks have performed well and now form a larger part of your portfolio than desired, you might sell some and reinvest in other assets to restore your original allocation.
• Focus on quality investments: Stick with well-performing, reputable companies with strong fundamentals. These companies are better able to withstand market declines.
• Diversify your investments: Spread your risks by investing in various types of stocks, sectors, countries, and investment instruments like bonds and ETFs. A well-diversified portfolio offers more stability during market volatility.
• Maintain a long-term perspective: Think about your investment horizon. A long-term perspective means focusing on your financial goals that are five, ten, or even twenty years into the future. Short-term fluctuations are less important if you have a long-term perspective because the market tends to recover over longer periods.
• Keep cash reserves: Having some cash on hand provides flexibility and the ability to take advantage of buying opportunities during market declines. Cash reserves ensure that you are not forced to sell your investments in the event of a sudden expense or emergency.
• Consider dollar-cost averaging: This means investing a fixed amount regularly, such as monthly or quarterly, regardless of market conditions. This allows you to buy stocks at different prices, lowering the average purchase amount and reducing the impact of market volatility.
• Review your stop-loss orders: If you use stop-loss orders to limit potential losses, check and adjust them based on current market conditions.
• Stay informed: Keep up with news and economic indicators, but do not overreact to short-term events.
• Reassess your risk tolerance: Periods of high volatility can test your risk tolerance. If you are losing sleep over your investments, your risk may be too high. Reassess your comfort level with risk and adjust your strategy accordingly.
• Focus on strong financial health: Ensure that your personal finances are in good shape. Invest only capital that you do not need immediately, so you are not forced to sell investments during downturns.

Conclusion

Market volatility can be frightening, but with a thoughtful and strategic approach, you can protect your investments and even benefit from the opportunities that arise. By staying calm, reviewing and diversifying your portfolio, and maintaining a long-term perspective, you can better manage the challenges of a turbulent market. Stay well-informed and ensure your financial foundation is strong so that you can navigate difficult times with confidence.