Timing isn't always everything
It’s hard to know when a bear market—widely defined as a decline of at least 20% from the highs—will strike. No one can say for sure if and exactly when the market will fall significantly or when a financial downturn might occur. However, it’s best to be prepared for the possibility.
A strategy to help defend against significant portfolio losses is a well-diversified portfolio with an asset allocation that matches your risk tolerance and time horizon. That may not take all the sting out of a severe decline. While asset allocation does not assure a profit or protect against a loss in declining market, it can help you design a portfolio that matches your risk tolerance and time horizon, so you’re in a better position to ride out the declines and stay invested until the next upward move.
What is asset allocation?
Asset allocation is the mix of stocks, bonds and other types of investments you own. It plays a central role in determining your portfolio’s performance.
Here’s why: Different asset classes behave differently under varying market conditions. The circumstances that might make, say, large-cap technology stocks tank, could be ideal for high-yield bonds, and vice versa. In other words, when one type of investment zigs, another may zag.
Having lots of different asset classes, therefore, allows you to participate in these different market moves. By hedging your bets this way, your portfolio probably won’t rise as much as a broad bull market, but it also is unlikely to fall as much as a broad bear market.
Is your portfolio’s asset allocation where it should be?
Because of the strong stock market returns in recent years, you might be sitting on a more stock-heavy portfolio than you intended, meaning you’ve taken on more risk than you might realize. Perhaps you started out with a 60% stock/40% bond split, but now you are closer to 80% stocks and 20% bonds due to these market moves.
In order to get back to your intended asset allocation, you may need to rebalance from time to time. That might feel painful, because it essentially means pulling money out of winners to prop up laggards. But rebalancing can help you achieve a more diversified portfolio.