When the stock market slides between 10% and 20%, it's called a correction. You may not recall the last one because it ended in
Some strategists say stocks look pricey, setting the stage for a potential fall. The S&P 500 trades at about 24 times corporate earnings for the past 12 months. That is more expensive than the market has been 90% of the time since 1928, says
That doesn't mean stocks can't keep climbing. Corrections within a bull market are often temporary reversals that end after a few months. (If a correction extends beyond a 20% drop, it turns into a bear market). Many strategists say the current bull market is supported by a healthy economy, modest inflation and interest rates that remain near historic lows.
Still, if you're nervous about a correction, here are five moves you can make now, potentially saving you a bundle if the market starts to skid.
Rebalance Your Portfolio
If you've held stocks for a few years, your portfolio may now be tilting excessively toward stocks. For example, say you aim to maintain a mix of 65% in stocks and 35% in bonds. If your stocks have gained 20% while your bond holdings have stayed flat, your mix will have shifted to 69% stocks and 31% bonds.
Waiting for stocks to correct would bring your portfolio back into alignment. But you'll lock in some profits if you rebalance now -- selling some stocks and buying more bonds.
If you do rebalance, sell stocks that may be most vulnerable to losses in a correction. Technology stocks, for instance, have been the top-performing sector in the S&P 500 this year, gaining an average 25.4%. That has put tech stocks on a precarious perch. "If you've had a great run in tech stocks, pull some money off the table," says Stack.
One way to determine if you own too much tech is to compare your portfolio's allocation to that of the market. Many brokers provide a portfolio "x-ray" tool that can analyze all your funds and stocks to assess your total exposure to each sector. The S&P 500 currently holds about 23.5% in technology stocks. If your portfolio includes more than that, you're "overweight" and should scale back to about 20%.
Stack also recommends trimming financial stocks -- another top-performing sector that looks susceptible to a fall. Financials make up 14.2% of the S&P 500; if you own a higher percentage, he says, consider cutting back.
Buy Low-Volatility Stocks
A falling market may pull everything down. But big, stable companies with steady revenues and dividends should lose less than the average.
Among ETFs that focus on such stocks, our top choice is iShares
One caveat: The ETF trades at a steep 23 times estimated earnings for the next 12 months, compared with about 18 times for the S&P 500. Low-volatility stocks have rarely been this expensive, and their steep valuation may cap the ETF's potential for gains.
Emphasize Defensive Stocks
Another way to protect against a downturn is to buy classically defensive stocks, such as health care companies, phone-service providers and utilities.
For broad exposure to health care stocks, we like
For utilities, we recommend Fidelity MSCI Utilities ETF (FUTY, $35.66). It holds a collection of 75 power producers, regulated utilities, gas distributors and other business. The ETF yields 3.0% and possesses a wafer-thin annual expense ratio of 0.08%. Fidelity brokerage customers can buy it commission-free on the firm's site.
Among phone-service providers, we like
Hold More Government Bonds
Backed by the "full faith and credit" of the
The big drawback of Treasuries, of course, is their sensitivity to interest rates: Prices of Treasuries fall as rates rise, and it can take a long time for interest payments to make up for the losses, especially if you own long-term bonds, which are the most sensitive to rate swings.
Nonetheless, rates appear to be boxed in a relatively narrow range for now. Kiplinger expects the yield of the 10-year
An ETF that should also hold up well if stocks slump is iShares Core
Boost Your Cash Reserves
Holding a lot of cash in your portfolio can hurt when the market is rising. But you'll be happy to have it if stocks swoon, giving you plenty of dry powder to buy shares at lower prices.
As an alternative to money market funds, which yield very little after fees, Stack suggests buying
Most online brokers don't charge fees or commissions when you purchase T-bills. If you buy directly from TreasuryDirect.gov, you can get a slightly higher yield, though it will be fractions of a penny on the dollar for bills maturing in a few weeks or months.
Either way, earning 1% in T-bills will feel better than losing 10% or more in a correction. "Investors tend to be more aggressive during the mature phases of a bull market, when there are no storm clouds on the horizon," says Stack. "But that is when you should start down a more defensive path."
Daren Fonda is an associate editor at Kiplinger.