With the stock market falling for much of 2022, investors are rediscovering the risk involved in investing. The sad truth is that your money is always subject to a risk of loss whether invested or not. Therefore, it’s crucial to use parts of your money in different ways to create an end-to-end portfolio that works better for you. You can’t completely eliminate risk, but you can manage it in ways that improve your overall chances of success.
If you want to make your overall portfolio more resilient, you need to put some form of risk management at the heart of your plan. Individually, the investments below may not seem like much, but together these three decisions bring your overall portfolio that much closer to unstoppable, even in This Market.
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It might seem odd to think of cash as unstoppable, especially at a time when inflation is heating up. Despite this challenge, cash has one key advantage over other asset classes: it’s what you use to pay your bills. In addition, it is the benchmark against which other assets are measured. As a result, as terrible as cash’s performance this year has been relative to inflation, it is far beaten to invest in the stock market.
Of course, if cash beats stocks over the long term, then we all have much bigger worries. As a result, while it is important to have some Cash, it is also important not to overdo it. A good guideline is to have enough cash to pay your bills, plus about three to six months of expenses in an emergency fund in case you face one of those unfortunate “life happens” moments.
Much more than that and you run the risk of exposing too much of your money to inflation. Much less, and you’ll be at greater risk of having to sell your stocks while they’re down to cover unexpected expenses.
#2: High quality bonds
When you have bills that you expect to pay out of your portfolio within the next five years, stocks can be an incredibly dangerous place for that money. If the market crashes (like in 2022) and you’re forced to sell your stocks to cover your bills, then you’ll be forced to liquidate as many more stocks to cover your costs.
For money you need in the short term, bonds have some key advantages over stocks. First, typical bonds have predictable payments — regular payments of interest on published dates, followed by a return of principal at maturity. That makes bonds much better than stocks for duration adjustment — turning an investment into cash just before you need it.
In addition, bond payments take precedence over stocks. When a company fails to make a scheduled bond payment, it typically results in bankruptcy — and potentially the company’s assets are handed over to those bondholders. As a result, if a company can make its bond payments, it is likely that it will will make his bail payments.
Still, a company’s ability to make its bond payments depends on a combination of its balance sheet strength and its ability to generate cash. So keep an eye on these and stay with companies that appear to be able to keep making these payments to improve your chances that your bond investments are truly unstoppable.
Of course, the biggest downside to bonds is that with generally fixed cash flows and a known lifespan, their total returns are also typically limited. As a result, while bonds are often better returns than cash for these short-term needs, they often aren’t great tools for long-term wealth accumulation.
#3: Broad-based equity index funds
Despite the challenges we see in 2022, there is good reason to believe that equities will continue to be an excellent vehicle for wealth accumulation over the long term. When it comes to stock investing, low-cost, broad-based stock index funds tend to outperform actively managed mutual funds. This makes broad-based stock index funds an incredibly powerful investment option for long-term money.
However, as 2022 reminds us, the stock market can go down as well as up. That’s why stocks — as unstoppable as they may be over the long term — aren’t where you want to hold money that you have to spend in the short-term.
Combine them all for a far more powerful portfolio
Cash, bonds, and stocks each have their own tradeoffs and risks that mean they’re not really suited to being the only investment vehicle you use. Put them together with one eye towards each other if However, they do need the money you save, and they each become fundamental elements of a much more unstoppable portfolio.
If you’re ready to put the pieces together for yourself, there’s no better time than now to get started. Make it a priority today and accelerate the date when your end-to-end portfolio has a better chance of meeting your needs when you need it.
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Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.