Unless you’ve been living in a cave for the past couple years, you know all about the stock market soaring into the stratosphere. Hopefully you’re invested in the market and have enjoyed the wild run-up in values.
As I write this at the beginning of 2018, we’re in the middle of one of the longest bull markets in history. It’s been almost nine years since the financial crisis market low in 2009. Over that time, the S&P 500 is up over 300%, not including dividends. The only time it went up more was from 1987-2000, when it climbed over 500%.
The Dow is also at record levels, eclipsing 25,000 for the first time ever.
And you’ve also heard about the dreaded “stock market bubble.” Obviously, it would be wonderful for us investors if the markets just kept going up at the current rates. But we all know that’s not going to happen. At some point, we’ll have a “correction” in the markets.
Vanguard, one of the most trusted investment advisors, has predicted a 70% chance of a correction in 2018 and no better than 4-6% returns over the next 5 years.
So what can you do about it?
Smart investors know you shouldn’t panic and start selling off your stocks in a declining market. The traditional wisdom is to stay calm and ride out fluctuating markets.
But certainly you can make some adjustments. If you’ve been heavily vested in the markets over this long 9-year bull run, like we have, then you’re blessed with some nice earnings. Why not take some of that profit and play around with it?
While my wife, Allison, and I will certainly be keeping the vast majority of our holdings in the market, we also like the idea of hedging our bets a little with a few different strategies. Disclaimer: None of the following should be considered advice for your own investment strategy. Feel free to borrow ideas, but know that there are risks involved with all these moves!
Here are the 5 different strategies we’ll be using to hedge against the potential upcoming bear market, including the level and risk and reward we associate with each strategy…
1. Double Our Cash Reserves (Low Risk, Low Reward)
Probably the lowest risk move to hedge against a bear market is to move more into cash (but beware that returns are meager). We currently keep about 6 months worth of expenses in cash accounts. This year, we will be doubling that to a full year of expenses.
Fortunately, this is still a relatively small percentage of our overall holdings. I don’t recommend holding more than about 10% of your portfolio in cash unless you’re either a) very risk averse, or b) don’t need the much higher earning potential of stocks.
When you move money into cash, make sure you to shop around for the best APY. There are a lot of options out there, including a number of online banks and credit unions, that will pay over 1% APY. While this is far from what you’ll hope to average in the stock market, and even lower than inflation, it still beats a negative return from a possible market correction year.
We currently keep most of our cash in Capital One, which pays 1.30% APY. And we’re on the waiting list for a new online bank account called Beam, which will (supposedly) pay a guaranteed 2-4% APY. You can learn more about them, and sign up for the waiting list here. (Disclaimer: If you sign up with that link, I get bumped up a bit on the list. And you can do the same if you give your sign up link to others.)
Note, there are other cash-like vehicles to park your money like CDs, but we like the flexibility and liquidity of pure cash savings accounts. You never know when you may need to pull out some money for an impromptu trip or unexpected emergency.
2. Rebalance Our Stock / Bond Ratio (Medium Risk, Medium Reward)
Another relatively safe hedge against a potential bear stock market is to rebalance your portfolio by moving some of your stock holdings to bonds.
In general, bonds tend to perform better than stocks in bear markets. During the financial crisis year of 2008, for instance, stocks lost 37% of their value while bonds gained about 5%.
The question of what percent of stock vs bonds you should hold in your portfolio can be quite complicated, but it mainly boils down to two things: 1) how risk averse (or tolerant) you are, and 2) what your time horizon is.
How risk averse are you? Would you have a nervous breakdown if you lost more than 10% of your holdings in a year? Or are you willing to invest heavily in stocks with an eye toward long-term growth, knowing you could lose money in any given year?
As for time horizon, if you’re young and still have say 20+ years before retirement, there’s really no reason you shouldn’t be investing heavily in stocks. You have plenty of time to rebound from any down years, and the power of compounding requires time.
“Compound interest is the 8th wonder of the world.” -- Albert Einstein
When we started investing for retirement 20 years ago, we decided that our investment portfolio would be pretty aggressive (85% stocks / 15% bonds) because we thought we would have many years to recoup any losses before we stopped working. This has been a good thing for us over the past 9-year bull run. However, we did suffer significant losses in the 2008-2009 economic crash. Fortunately, we decided to keep our portfolio intact and not sell anything off, so those funds were able to eventually recover and even thrive.
This year, we’re finally going to start scaling back our stock-heavy portfolio to about a 75% stock / 25% bond mix. And then 70/30 in 2019, 65/35 in 2020, and 60/40 in 2021. Of course, we can always change that plan if our own circumstances change, or something changes significantly in the marketplace.
If you’re not sure what mix is right for you, the traditional rule of thumb is to take 100 minus your age, and that’s the percentage of stock you should own. For example, if you’re 35, then you should have 65% in stock (100 minus 35). Just note that this rule may be a bit conservative and outdated due to higher life expectancies.
3. Cryptocurrency Day Trading (High Risk, Medium-High Reward)
This is our most unorthodox and risky hedge for 2018. The verdict on cryptocurrencies is still out, with some very smart people on both sides of the aisle.
I have some friends that I consider very intelligent and successful who have put a fair amount of money into crypto and believe it’s the future of currency.
On the flip side, Warren Buffett, one of the world’s most revered investors, said this recently about cryptocurrencies: “I can say almost with certainty that they will come to a bad ending.”
And Mr. Money Mustache, another financial blogger, wrote an insightful piece called “Why Bitcoin is Stupid.” While the title sounds simple and silly, the article is very well written and researched.
I personally feel more like Buffett and Mr. Mustache than the oodles of “investors” pouring money into cryptocurrencies such as Bitcoin, Bitcoin cash, Ethereum, Litecoin, Ripple, etc.
That being said, I’m not above dabbling in this new “investment” vehicle. My feeling is that it’s worth putting a small amount of money into, so long as you don’t mind potentially losing that money. It’s like going to Vegas -- you give yourself a certain amount of money to play with. If you make money, great. If you lose it all, it’s a bummer, but you had fun losing it. And most importantly, it’s an amount you can afford to lose.
I started dabbling a few months ago by putting a little cash into Bitcoin. I figured that was the one most people knew about and would continue buying. I’m not so sure about Bitcoin now -- mainly because of the enormous amount of energy it takes to mine. It’s not sustainable, and the conservationist in me doesn’t like what it could do the planet.
There’s also so much information and disinformation about all the various cryptos out there. I try to read up on them as much as I can, but that could be a full-time job in itself.
So rather than trying to figure out what the next big crypto will be, I’ve decided to just have some fun with it. I’ve always wanted to dabble in day trading, so I’m going to day trade crypto. Mind you again, we’re talking about playing with “fun money” that I can live with losing. But the spreadsheet geek in me enjoys playing with numbers and strategizing.
If you’re feeling adventurous and want to try crypto day trading yourself, here’s a really good primer.
4. Spend More on Experiences (Low Risk, High Reward)
As they say “You can’t take it with you.” The “it” is all the money you’ve accumulated in your nest egg over the years.
Allison and I have been faithfully saving, investing, and living frugally over the past 10+ years. The fruits of this lifestyle have allowed us to become financially independent and retire from working “real jobs” while still in our early 40s.
We recently came to the realization that we should start liquidating some of our investments and spending some of that hard earned money on ourselves, because, again, you can’t take it with you. For us the best way to splurge is on experiences. We don’t need or want any expensive physical things at this stage in our lives. We’d much rather use our money on doing things that are fun, interesting, and meaningful.
Because we’re still frugal at heart, our experience to-do list is very affordable. Here are some of the activities we’re looking forward to this year:
- Food -- we’re going to try a new restaurant for lunch every Tuesday and Thursday. We got this idea from Allison’s dad, who’s been doing “Tuesday night dinners” with a group of friends in NYC for years.
- Movies -- have you heard of MoviePass? It’s almost too good to be true, but you get access to unlimited movie theatre movies (except 3D movies) for only $9.95 per month. We got it even cheaper through Costco for $89.99 for the year. Maybe we’ll even splurge for some popcorn at the theatre...
- Massages -- who doesn’t love a good massage? We’ll be trying new local massage therapists through Groupon and other daily deal specials. We’ll also occasionally splurge on a spa retreat somewhere in the Bay Area.
- Travel -- we’ve always included travel in our yearly budget, but we’re going to make sure we use it specifically for one big trip and a couple smaller ones. This year’s big trip is China, and next year’s will be Australia & New Zealand.
And that completes our journal of stock market bubble hedge strategies! Some of these strategies are tame and safe, like increasing your cash holdings. Others are quite risky and out there, like cryptocurrency day trading.
I hope this gives you some of your own ideas for weathering the next downturn, whenever that might be. And who knows, you might even enjoy the ride!