Build a portfolio for downturns by matching its asset mix to your goal, time horizon, and capacity and willingness to accept losses; diversifying both across and within asset categories; and rebalancing by a rule you set in advance. Diversification can help manage risk, but it cannot prevent losses or guarantee that investments will hold their value when markets fall.
Start with the goal and the date you need the money
Before choosing investments, identify what the money is for and when you expect to use it. The U.S. Securities and Exchange Commission (SEC) says an appropriate asset mix depends substantially on your time horizon and risk tolerance. Risk tolerance has two parts: your willingness to experience losses and your financial ability to bear them.
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A long-term goal may allow more short-term volatility than a goal that is only a few years away. But choosing too little investment risk for a distant goal can also make it harder to meet growth needs. There is no single stock, bond, and cash allocation that suits every investor; the right mix depends on your circumstances. The SEC’s beginner’s guide to asset allocation, diversification, and rebalancing explains these principles. This is general educational information, not a personalized allocation recommendation.
Choose asset categories before choosing funds
Stocks, bonds, and cash are common building blocks, but they do not carry identical risks or behave in a guaranteed way during downturns. The SEC describes stocks as historically having higher risk and higher potential returns; bonds as generally less volatile, with more modest returns; and cash equivalents as generally having low investment-loss risk but being vulnerable to inflation.
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- Stocks: They can offer growth potential, but their values can fall significantly. The SEC guide says large-company stocks as a group have lost money on average about one out of every three years. The guide does not specify the observation period, so this is not a forecast or a measure of how often bear markets occur.
- Bonds: They may behave differently from stocks, but they are not guaranteed protection. Bond risks vary, and high-yield bonds carry higher risk.
- Cash and cash equivalents: They may be useful for money needed sooner, but inflation can erode purchasing power over time.
Other asset categories have their own risks. Do not assume that every asset will behave differently in every market decline, or that adding a category automatically reduces losses.
How do I diversify my portfolio within each category?
Diversification means spreading investments across asset categories and also across investments within each category. For stocks, that can mean exposure to a broad range of companies and industries rather than relying on a small number of individual shares. For bonds, consider whether holdings are concentrated in particular issuers or types of bonds.
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Mutual funds and exchange-traded funds (ETFs) can make it easier to own portions of many investments, but a fund label or a large fund count does not prove that a portfolio is diversified. Funds may hold many of the same large positions, and a narrow sector fund can add concentration rather than broad exposure. Review the underlying holdings and sector exposure of the funds you own. The SEC explains this distinction in its overview of mutual funds and ETFs.
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Build resilience through a mix that fits your goal and through diversification—not by assuming you can avoid every market loss. The SEC says that including asset categories whose returns move up and down under different market conditions can help protect against significant losses. It also cautions that “Diversification can’t guarantee that your investments won’t suffer if the market drops,” as Investor.gov’s diversification explanation puts it.
That distinction matters: diversification is a risk-management approach, not insurance. A downturn can affect many holdings at once, and investments that usually behave differently may still fall together. Avoid changing your allocation solely in reaction to a market forecast; instead, use a plan tied to your financial goal and risk tolerance.
Set a rebalancing rule before markets move
Over time, investment categories can grow or shrink at different rates, leaving your portfolio with a different risk mix from the one you chose. Rebalancing brings it back toward the intended allocation. The SEC describes two broad ways to decide when to review:
- Calendar-based review: Check the allocation at regular intervals. The SEC guide notes that some experts use intervals such as six or twelve months; these are examples, not a recommendation for every investor.
- Threshold-based review: Rebalance when a category moves beyond a percentage band you set around its target. The SEC describes this as another approach but does not prescribe a universal threshold.
Whichever method you choose, the SEC says rebalancing generally works best when relatively infrequent. You can trim categories that have grown beyond their intended share, add to categories that have fallen below it, or direct new contributions toward underweight categories. Before selling, consider possible tax consequences and transaction costs; those can affect which method makes sense for you. If the tax or fee implications are difficult to assess, a qualified financial or tax professional may help.
Could a target-date fund simplify the process?
A target-date, or lifecycle, fund pools investments and typically shifts toward a more conservative allocation as its target year approaches. The fund’s adviser manages its asset allocation and rebalancing, which can suit someone who prefers a packaged approach. The SEC’s target-date fund overview describes how these funds work.
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A target date does not make a fund a guarantee against losses or ensure that its strategy matches your needs. Review the fund’s date, holdings, investment strategy, risks, and costs, and assess whether it fits the goal the money is intended to support.
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