The group instinct kicks into overdrive when mutual fund investors hear the word recession and news reports show stock prices dropping. Fears of further declines and mounting losses hunt investors out of stock funds and push them toward bond funds in a flight to safety. It is an effective tactic for investors who are seeking to avoid risk and are smart or lucky enough to sell while their portfolios are still on the positive side - but it's not the only strategy available to combat tough times. Here are few points which will help you to find out what else you can do in the face of a recession.
There are many kinds of bond funds that are mainly popular with risk-averse investors. Funds made up of Treasury bonds direct the pack, as they are considered to be one of the safest. Investors face no credit risk, as the government's ability to levy taxes and print money removes the risk of default and provides principal protection.
Next one on the list is municipal bond funds. Issued by state and local governments, these investments leverage local taxing authority to offer a high degree of safety and security to investors. They carry a greater risk than funds that invest in securities backed by the government, but are still considered to be relatively safe.
Taxable bond funds issued by corporations are also a consideration. They offer higher yields than government-backed issues, but carry significantly more risk. Choosing a fund that invests in high-quality bond issues will help lower your risk. While corporate bond funds are riskier than funds that only hold government issued bonds, they are still less risky than stock funds.
When it comes to avoiding recessions, bonds are definitely popular, but they are not the only game in town. Ultra-conservative investors and unsophisticated investors often hide their cash in money market funds. While these funds do provide a high degree of safety, they must only be used only for short-term investments.
Converse to popular belief, seeking shelter during tough times does not necessarily mean abandoning the stock market altogether. While investors stereo usually think of the stock market as a vehicle for growth, share price appreciation is not the only game in town when it comes to making money in the stock market. For instance, mutual funds that focus on dividends can provide strong returns with less volatility than funds that focus strictly on growth. Utilities-based mutual funds and funds that invest in consumer staples are less aggressive stock fund strategies that tend to focus on investing in companies that pay predictable dividends.
Traditionally, funds that invest in large-cap stocks tend to be less vulnerable than those that invest in small-cap stocks, as larger companies are usually better positioned to endure tough times. Shifting assets from funds that invest in smaller, more aggressive companies to those that bet on blue chips provides a way to cushion your portfolio against market declines without fleeing the stock market altogether.
For richer individuals, investing a portion of your portfolio in hedge funds is one idea. Hedge funds are designed to make money regardless of market conditions. Investing in a foul weather fund is another idea, as these funds are specially designed to make money when the markets are in decline.
In both cases, these funds must only represent a small percentage of your total holdings. In the case of hedge funds, "hedging" is the practice of attempting to reduce risk, but the actual goal of most hedge funds today is to maximize return on investment. The name is typically historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds usually cannot enter into short positions as one of their primary goals). Hedge funds usually use dozens of different strategies, so it is not accurate to say that hedge funds just "hedge risk." In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market. In the case of foul weather funds, your portfolio may not fare well when times are good.
While bond funds and similarly conservative investments have shown their value as safe havens during tough times, investing like a lemming is not the right strategy for investors seeking long-term growth. Trying to time the market by selling your stock funds before they lose money and using the proceeds to buy bonds funds or other conservative investments and then doing the reverse just in time to detain the profits when the stock market rises is a risky game to play. The odds of making the right move are accumulated against you. Even if you achieve success once, the odds of repeating that win over and over again throughout a lifetime of investing simply are not in your favor.
A far better strategy will be to build a diversified mutual fund portfolio. A correctly constructed portfolio, including a mix of both stock and bonds funds, gives an opportunity to participate in stock market growth and cushions your portfolio when the stock market is in decline. Such a portfolio may be constructed by purchasing individual funds in proportions that match your desired asset allocation or you can do the entire job with a single fund by purchasing a mutual fund that has "growth and income" or "balanced" in its name.
Regardless of where you put your money, if you have a long-term time frame, always look at a down market as an opportunity to buy. Instead of selling when the price is low, look at is an opportunity to build your portfolio at a discount. When retirement becomes a near-term possibility, make a permanent move in a conservative direction. Do it because you have enough money to meet your requirements and want to remove some of the risk from your portfolio for good, not because you plan to jump back in when you think the markets will rise again