First of all, I am not a financial advisor and I have no idea what the stock market is going to do next. I’m just trying to play defense on my IRA and you need to do your own research before making big changes to your investment. The reason why I’m writing this article is because I need to research and figure out what to do. Hopefully, I can get some suggestions from more experienced investors as well.
Last November, I rolled over my 401(k) to an IRA and invested everything in the stock market. This was a bit risky because my bond allocation went way down. Luckily, the stock market did very well and my IRA is up over 10% since I rolled it over. I’m very happy with that gain and I feel like that’s enough for 2013. I sold off most of the equities in the IRA and now I’m looking for a safe place to stash the cash while waiting for the opportunity to get back in again.
My goal for the rest of 2013 is 1-2% gain. I have been doing some research and it’s kind of tricky because there are risks and tradeoffs with any investments. Let’s take a look at some defensive investments that should be able to weather a stock market correction (a 10% decline.)
Money Market Funds
Since this is my IRA, I can’t just put it into a high yield saving account. The interest rate is very low at around 1%, but I would be happy with that. In the past, a good alternative to a saving account is the money market funds. Money market funds aim to earn interest for share holders while holding the value of your dollar. These days, the yields are rock bottom at around 0.01%. It’s basically the same as holding cash and I would like a little more return than that.
When you buy bond, you are lending money to an entity and receive interest payment. I plan to get back into the stock market later this year or early 2014 so I can’t buy bonds and hold them until maturity. Bond funds are a good option though. They will give a little higher return than money market funds. However, we all know the government will raise the interest rate at some point. This will impact bond funds and cause the price to go down. That’s why I have been reluctant to invest in bond. From what I understand, short term bonds will be least affected so that’s what I will concentrate on.
The Vanguard Short-Term Government Bond ETF (VGSH) yield 0.13% and the expense ratio is 0.12%. This looks like a mediocre choice to me. At best, we would collect 0.01% and if the interest rate rises, I’m sure the fund will drop more than that.
The Vanguard Short-Term Corporate Bond ETF (VCSH) yield 0.82% and its expense ratio is 0.12%. This is a bit better than Treasury bond, but it is also a bit more risky. I’m not sure what will happen to the bond price if we have a big stock market correction. It will probably hold up fine unless a bunch of blue chip companies go out of business and can’t pay back these loans. It would take a major meltdown to do that though and I don’t think that’s going to happen anytime soon.
High Yield (Junk Bond)
Junk bond has better yield than high grade corporate bond because the risk of default is much higher. I have never invested in junk bond before so I will need to proceed cautiously. Fidelity High Income (SPHIX) yield 5.32% and cost 0.76%. This sounds quite attractive actually, but I’ll probably invest a very small percentage of my portfolio here since I don’t have experience in this area.
Municipal bonds are tax free so generally it’s not placed in a tax deferred IRA. From what I read, the yields have fallen and interest rate risk has risen. Now is probably not the right time to buy municipal bonds.
Vanguard GNMA Fund Admiral Shares (VFIJX) specializes in government mortgage-backed securities. GNMA securities are backed by the U.S. government and typically offer a higher yield than Treasury bonds. VFIJX yields 2.65% and the expense ratio is 0.11%. When mortgage refinance activity is high, the yield is likely to decrease because the mortgage loans aren’t carried out to maturity.
Another way to weather a stock market correction is to invest in defensive stocks. Defensive stocks generally weather a down market better than other stocks, but don’t perform as well during a bull market. These days we can easily shift into defensive sectors through Vanguard ETFs. Utilities (VPU), healthcare (VHT), and consumer staples (VDC) are doing quite well lately. Investors need to know that this is much riskier than investing in bonds.
I feel the stock market ran up quite a bit this year and it’s probably due for a correction at some point. The stock market also has been very volatile lately and my IRA is happy to sit it out for a while until it settles down. When I was working, I generally just ignore the stock market swing because I can keep averaging in during a down market. Now that I can’t add as much money, I will need to limit my losses more by investing defensively.
After looking over this list, I think I’ll go with short term corporate bond and GNMA for the most part. I’ll invest a small portion in high yield so I can see what it’s like. I would love to hear some advice from investors with more experience. What would you invest in when your main goal is to preserve capital in the short term? Did I miss anything? Gold?
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