You know that for the long-term growth of your IRA account assets, you need to be invested in the stock market. The trouble with the stock market is the occasional bear market, which can result in a big drop in your account value. Solutions to protect your IRA assets from a market downturn range from proper long-term planning to short-term strategies that keep losses to a minimum.
Age-Appropriate Asset Allocation
Asset allocation divides your investments into different types of investments, primarily stocks and bonds. Additional asset classes could include precious metals, real estate, and foreign stocks and bonds. The asset allocation percentages in your IRA should be age-appropriate. In your twenties or thirties, it is fine to have 70 percent to 80 percent of your account in stocks. If the market drops, the allocation rebalancing will pick up an extra portion of cheap stocks during the downturn. When you are close to retirement age, the stock portion of your retirement accounts should be small enough so that a 20 percent to 40 percent short-term drop in the market would not affect your retirement plans.
Cash is King
If you expect the markets to make a significant drop, moving a portion of your IRA assets into cash will allow you to buy stocks when they get cheap. The time to move into cash is before the market really starts to decline. Selling at the bottom would just lock in your losses. Because it is impossible to predict how far prices will drop or how long a bear market will last, it might be appropriate to always have some portion of your IRA available for investment. Adjust the portion of cash in the account based on whether you think the market has gone up too far, or whether you think it's reaching a bottom and you want to get closer to fully invested.
Dividend Stocks or Funds
Owning dividend-paying stocks, or funds that own dividend stocks, allows your IRA to earn dividend income while the stock market works its way through a bear market. The dividend yield of a stock helps put a floor on how low the market will let this type of stock fall. Invest your IRA money in stocks that have histories of maintaining or increasing dividend payments through all phases of the stock market cycles. If you are worried about a downturn in the stock market, lighten up on your positions in growth stocks that don't pay dividends.
Index Put Options
If you want to hold on to your stock investments and offset any market downturn with other profits, you can buy put options that will increase in value if the market drops. Puts trade against the major stock market indexes and exchange traded funds, or ETFs, that track those same indexes. You can add options trading privileges to a stockbrokerage IRA account. Put option contracts have expiration dates, so the protection provided will be good for a limited amount of time -- typically three to six months. The cost of puts would be relatively small compared to the amount of downside protection the contracts could provide.
- U.S. Securities and Exchange Commission: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing
- Putnam Institute: Optimal Asset Allocation in Retirement: A Downside Risk Perspective
- Fidelity: Retired? Three Strategies for a Down Market
- The Options Guide: Portfolio Hedging Using Index Options