Although stock market dips are a normal feature of equity markets, that doesn’t mean you can’t prepare for them. Consider some of the following steps to protect your portfolios against a downturn:

(i) Diversify into Different Sectors and Countries

Collective investment products such as funds and investment trusts offer a ready-made, diversified portfolio of share-based assets. This is a lower-risk option than investing directly in individual companies.

Buying funds or ETFs covering different geographic or industry sectors will reduce volatility and the risk of one or more sectors underperforming. Legendary investor Sir John Templeton extolled the virtue of diversification, saying that “The only investors that don’t need to diversify are those that are right 100% of the time.”

As finance expert Tony Featherstone states in ASX Investor Update: “Income investing is about more than yield. It’s also about managing risk by building and maintaining a diversified portfolio across asset classes. This is especially important for older investors, such as retirees, who want income and capital stability.”

(ii) Diversify into Different Assets

Which brings us to diversification into non-equity-based assets, such as bonds, property and commodities, that may also protect your portfolio in the event of a stock market crash.

It’s important to pick assets that aren’t correlated, in other words, their price movements do not move up and down together, but rise and fall at different times. That way, if one asset falls in value, this should hopefully be offset by other assets holding, or increasing, their value.

If you are looking for a low-cost way to diversify, then there are a number of Exchange-Traded Funds (ETFs) that track the prices and/or indices of certain asset classes, including commodities. Most ETFs in Australia are passive investments, and try to replicate the performance of an index. ETFs track a range of asset classes, including precious metals and commodities, bonds, crypto, foreign currencies, as well as of course local and international shares.

(iii) Time Your Investments

It is very difficult to buy low/sell high when markets are volatile or a crash is imminent. However, there are still steps you can take in terms of timing your investments.

One option is to invest monthly, rather than as a lump-sum, allowing you to benefit from dollar cost averaging. This means that, if stock markets and share prices fall, investors are able to buy more shares or units for the same amount. As a result, investors end up paying the average price across the whole period.

As discussed earlier, investing for the long-term (at least 10 years) helps investors to protect against the impact of stock market crashes.

(iv) Consider Your Super Fund Exposure

The Federal Government’s Moneysmart site, recommends that your choice of superannuation be tailored to your risk appetite, age, and retirement age.

For example, it’s common for Australian workers in their 20s and 30s to opt for growth superannuation funds, with high exposure to shares, because if the stock market crashes they have time to regain the money before they retire.

If you are approaching retirement however, you may opt for a balanced or conservative super fund, as they better protect you from a share market crash. In a conservative fund, it is common for the investment mix to comprise around 30% in shares and property, and 70% in fixed interest and cash. Compare this to a growth fund with around 85% in shares or property, and 15% in fixed interest or cash. A ‘high growth’ option may involve 100% exposure to shares.

As in all cases, speak with your financial advisor to determine the best option for you.

(v) Other Tips for Protecting Your Portfolio

Other potential options for protecting your portfolio against a crash include:

  • Stop-loss and limit orders: these allow investors to set a price at which shares are automatically sold. A stop-loss order is an order to sell shares if the price falls to, or below, a set price (the “stop” price). For example, if you bought a share costing 100 pence, and you wanted to limit your downside risk to 10%, you could set a stop-loss order of 90 pence.
  • Holding cash: Of course, if you really want to ensure protection from the vagaries of the stock market then you could opt to keep your holdings in cash. Interest rates on the best savings accounts are as high as 5.75%, and are outpacing inflation.

Note: When investing, it’s possible to lose some, and very occasionally all, of your money. Past performance is no prediction of future performance and this article is not intended as a recommendation of any particular asset classinvestment strategy or product.