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Written by: Scott Airey
Taking advantage of the stock markets has historically been a great way to grow wealth. Back in 1952, a man by the name of Harry Markowitz came up with all of the investment theory and science that we use today known as Modern Portfolio Theory. In summary, Markowitz discovered that utilizing a well-diversified portfolio that considers investments that are defined as both safe and risky will over time will provide you opportunities to grow your wealth as well as a protector during volatile times.
If you haven’t noticed, 2022 has been a difficult time for investors as the markets are not experiencing what we would call a typical year. Macroeconomics indicators such as inflation, interest rates, government intervention, and people acting irrationally in the face of challenging markets, are creating a little bit of fear. However, the opportunity exists if you know where to look, but knowing the best place to put your investments in today’s markets is a daunting task for many investors.
Here are a few options that you can consider to help protect your nest egg and allow you to keep your cool and stay invested during some tough markets today.
High Yield Savings Accounts
During down markets liquidity is important, having to spend down assets in your retirement years comes with some major risks, and the sequence of your market's returns has more to do with your success than anything else. So have a bucket of assets that albeit not fairing well with this inflation is more likely doing a great deal better than say your bond or equity assets.
High Yield Savings Accounts act much like a savings account but utilize very short-term investments that virtually have no risk, but on the flip side, you might only experience a mere 0.6%. With that being said, the protection offered by a bank, and the high liquid is well worth the lack of growth to shield your investments from dropping markets and would allow you to take advantage of opportunities while the markets are essentially on sale. Lastly, as interest rates rise returns from this account should follow suit.
Certificates of Deposit - CDs
Another great option offered through banking channels can allow you to achieve greater returns than your high yield savings account with the same level of risk, but there is a catch. Most Certificates of Deposit will offer a fixed rate of return on your deposits, but you will have to leave your money on deposit with the bank for a specific period, otherwise, you lose a lot of the potential benefits found in these products. So, liquidity needs to be considered in your plan and other assets available for generating cash flow. This depends heavily on where you are in life and the unique goals you are trying to achieve but in today’s market, a fixed rate would feel pretty good!
The average fixed CD is going to get you somewhere between 1.5%-2%, however, banks have evolved over time and now allow most investors the opportunity to purchase what is known as a market-linked CD. Similar to its traditional CD counterpart, these investments offer principle protection with the opportunity to seek market return without actually participating in the markets. Head you win, tails you tie.
Several planning concepts can allow you to take advantage of these unique offerings, but there are some rules that you must be aware of before selecting a CD for a portion of your portfolio.
I-Bonds
These investments are issued by good old Uncle Sam through the United States Treasury dept. They are debt instruments, meaning that once you give the US government your money they will in turn give you back payments in the form of interest rates that get assessed pretty much every six months. During inflationary times I-Bonds have proven to be a good play but there is also what I would call a downside… We can only purchase a maximum amount of $10,000/year!
However, there are some sneaky legal planning strategies and tax benefits that if carried out could allow you to procure more than $10,000 per year. This type of planning does come with s is not in the scope of this article to dive into the logistics or legalities of this type of planning, so all I will say is to talk to an attorney and tax professional to get the proper advice for your scenario.
Index Funds
Remember that guy Harry Markowitz? Turns out his theory works well, the concept of building a portfolio that consists of a broad-based, non-correlation asset class proves to be very effective over the long run. Index funds. Track various groups of investments that fall into similar categories to spread out some of the investment risks without being overly diversified. The S&P 500 for example, is made of the largest 500 companies here in the United States and it represents the barometer of our market.
The main allure of Index funds comes from their high levels of diversification and simplicity of the portfolio design. These investments trade just like any other stock or bond and are also known for their low investment fees. Those aspects of an Index fund, to me, make them a great option in today’s markets and any market conditions for that matter. Keeping things simple is a great way to avoid additional stress and anxiety (which undoubtedly occurs for most investors) when managing a portfolio in declining markets.
There are a vast array of index funds available to just about all investors, making them attractive to everyone for the college student investing for the first time to Grandma and Grandpa who just retired and expect to live another 30 years. Most index funds will come with little to no shield from market volatility, but the primary goal of an index fund is typically long-term growth. In today’s market, many fund managers utilize sophisticated investing concepts through the use of algorithms and computer analysis to bring added benefits and protections to these simple investments.
These solutions are typically only offered through a financial advisor that has the appropriate training and licensing that allows them access to this form of investing, but you don’t need a lot of money in your savings to gain access to these options in your portfolio. Index funds have a place in just about every portfolio, time horizon, and long-term planning can make it very easy for an investor to know how and when to incorporate one of the many iterations of these funds.
Exchange-Traded Funds - ETFs
ETFs are similar to the aforementioned Index funds, they both utilize broad-based baskets of securities to make up a portfolio and they can be traded in the open market. Many ETFs purchase a particular index, sector, or commodity, allowing investors a greater level of specialization with a portion of their portfolio.
ETFs come with similar benefits as an Index fund with low cost, and simple investing, but they do start to stand out with their additional tax efficiency. Essentially you have much greater control over managing and ETF compared to an Index fund, which again I believe helps in maintaining the correct mindset during market declines.
Dividend Stocks
Small lump sums of cash paid to a shareholder of stock are known as dividends, but they only come company’s profits are high enough to distribute these payments as a reward for ownership. Dividends have in reality been a major factor in the level of growth experienced in the US, and they have proven to be fairly reliable in many different markets, but understand they are not guaranteed.
Liquidity during down markets can be a very good thing, dividends can be instrumental in creating short-term and consistent cash flow, but reinvesting those payments back into your portfolio is a great way to bolster investment returns. Especially during inflationary times.
Not all dividends are created equal, so be sure to investigate and do your due diligence before investing. With that being said, there are many different index funds and ETF portfolios that are designed specifically for the generation of dividends. Simplicity in your plan is paramount.
Alternative Investments
When investing some options come with inverse correlations to the markets, a disclaimer related to investment risk should be embedded right here, before we go further…
Alternative investments are complicated and come with some significant risk (typically), it is possible that one tine correction or change in the markets can result in a 100% loss of your investment.
If you are ok with volatile markets and have a well-rounded financial plan that would allow you to take on these additional risks, alternatives can be a great option for today’s markets. Just do me a favor and talk to an expert beforehand.
In summary, modern investors have a very wide suite of investment options, this environment changes regularly. Investment managers, banks, and insurance companies (to name a few) are constantly sharing new ideas and solutions. The world we live in is ever-changing, it is important to keep tabs on your options and weigh the pros and cons. Investing can be simple and profitable in any market, the key is to know your appetite for risk, your goals, knowledge, and financial situation. Those are key factors in deciding which investments in 2022 are best for you.