My father loved to ski. When I was young, he would take me to the mountains and deposit me on the bunny slope. The bunny slope was relatively flat and smooth -- perfect for beginning skiers.
When I got a little older, my father took me on one of the harder slopes. Initially, the transition was difficult. It was a much bumpier ride and I ended up on my backside more than a few times.
My father kept urging me to bend my knees more. Eventually, I listened and it was smooth sailing after that. In downhill skiing, when you bend your knees, you turn your body into a giant shock absorber, Instead of taking the full force of the bumps, you can glide right over them.
1) Dividends andDividend paying securities are good portfolio shock absorbers. As long as you're invested in companies and funds that can sustain their distributions, income keeps streaming in, regardless of market conditions.Reinvestment:
If you aren't reinvesting, this income can partially offset or stabilize capital fluctuations. If you are dividend reinvesting, you are effectively dollar cost averaging -- picking up more new shares at lower prices and fewer shares at higher prices.
2) Cash: We don't make much money on cash these days, but it's the ultimate portfolio shock absorber. Market goes up, you have cash. Market goes down, you have the same amount of cash.
And when the market gets bumpy, its nice to have a portion of your portfolio act as a stabilizer. Cash will also allow you to take advantage of lower prices and higher yields when those opportunities arise.
3) Income Bargains: It's hard to buy today, knowing the market can lurch lower tomorrow. In fact, trying to buy growth stocks this way can be a recipe for disaster. But buying solid income stocks at a low prices means you are locking high yields.
What's better than buying an income stock at a low price? Buying it at an even lower price -- and even higher yield. In bumpy markets, sometimes I'll put together a short list of income stocks I'd like to buy.
Then, I'll place limit orders to purchase these securities below the market price. Sometimes I can snag a solid income producer at a really low price on a temporary, but extreme, market bump.
4) Offset Capital Risk with Short Index Funds: Adding a short index fund to an income portfolio can offset some of your capital risk during a bumpy market. A short -- or inverse -- index fund will gain when the market drops.
Likewise it will drop in price when the market rises. Owning a short index fund can act as a capital equalizer. Some short index funds you might consider are ProShares Short S&P 500 (NYSE: SH), ProShares Short QQQ (NYSE: PSQ), ProShares Short Dow 30 (NYSE: DOG), ProShares Short Russell 2000 (NYSE: RWM).
Funds like these offer good short-term protection. But I want to emphasize "short-term" protection. Inverse and leveraged funds have some serious drawbacks, especially when held for longer periods.
For an explanation of those risks, see how The World's Smartest Investors Lost Money in These Tempting Traps and The Worst. Bear Market Investments for Your Retirement Account
The Investing Answer: I'm going to sit tight for the next couple of weeks. I'm going to receive and reinvest my dividends. I'm also going to put together a little bargain shopping list so that I'm ready if/when my favorite companies hit their sale price.