With the stock market down for much of 2022, investors are rediscovering the risk associated with investing. The unfortunate truth is your money is always at risk of some sort of loss, invested or not. Consequently, it is critically important to put some of your money to work in different ways in order to create an end-to-end portfolio that works best for you. You can’t completely eliminate risk, but you can manage it in a way that improves your overall chances of success.
If you want to make your overall portfolio more resilient, you need to put some sort of risk management at the heart of your plan. Individually, the investments below may not seem like much, but together, these three choices make your overall portfolio much closer to the unstoppable, even in this market.
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No. 1: Cash
It might seem strange to consider cash unstoppable, particularly in an era where inflation continues to rise. Despite this challenge, cash has a key advantage over other asset classes – it’s what you use to pay your bills. Furthermore, it is the yardstick against which other assets are measured. As a result, as dire as liquidity performance has been when measured against inflation this year, it has been distant beaten stock market investing.
Of course, if liquidity beats stocks over the long term, then we all have much bigger things to worry about. Consequently, 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 costs in an emergency fund in case you face one of those unfortunate “life happens” times.
Much more, and you will be at risk of having too much of your money overexposed to inflation. Much less, and you will be at greater risk of being forced to sell your shares while they are falling to cover an unexpected expense.
No. 2: High quality bonds
If you have bills that you expect to pay out of your wallet within the next five years or so, stocks can be an incredibly dangerous place for that money. After all, if the market goes down (as it did in 2022) and you depend on selling your shares to cover your bills, then you will be forced to liquidate a lot of other shares to cover your costs.
For the money you’ll need in the short term, bonds have some key advantages over stocks. First, typical bonds have predictable payments: regular interest payments on published dates, followed by a principal repayment at maturity. This makes bonds much more suitable than stocks for duration matching, turning an investment into cash just before you need it.
In addition, bond payments take priority over equities. If a company fails to make a scheduled bond payment, it typically leads to bankruptcy and potentially the company’s assets are sold to those bond holders. Consequently, if a company Power making bond payments, it is likely to want make your bond payments.
However, a company’s ability to make bond payments depends on a combination of the strength of its balance sheet and its ability to generate cash. So keep an eye on them and stick with companies that seem able to keep making those payments to increase your chances that your bond investments are truly unstoppable.
Of course, the main drawback of bonds is that with generally fixed cash flows and a known maturity, their total returns are also generally limited. As a result, while they can often provide better returns than cash for those short-term needs, bonds are often not excellent long-term wealth creation tools.
No. 3: Broad-based equity index funds
Despite the challenges we are seeing in 2022, there is good reason to believe that stocks will continue to provide an excellent vehicle for building wealth over the long term. When it comes to investing in stocks, low-cost, broad-based equity index funds tend to outperform actively managed mutual funds over time. This makes broad-based equity index funds an incredibly powerful investment choice for long-term money.
However, as 2022 reminds us, the stock market can go up or down. That’s why stocks – however unstoppable they may be in the long term – are not where you want to keep the money you need to spend in the short term.
Put them all together for a much stronger portfolio
By themselves, cash, bonds, and stocks each have trade-offs and risks that mean they’re not really suited to be the only investment vehicle you use. Put them together with an eye towards when you need the money you’re saving, however, and each of it becomes building blocks of a much more unstoppable wallet.
If you are ready to put the pieces together for yourself, there is no time like the present to start. 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 them.
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Chuck Saletta has no position in any of the titles mentioned. The Motley Fool has no position in any of the titles mentioned. The Motley Fool has a disclosure policy.