Since Donald Trump was elected president, the stock market, especially bank stocks, has stormed higher. The S&P 500 index has soared 10% on expectations that the Trump administration would implement a business-friendly agenda, stoking investment and growth.
Yet more than two months into Trump’s term, talk of tariffs and moves on immigration restrictions have made foreigners and citizens nervous. And the recent failure to pass a health care overhaul has some investors doubting the administration’s ability to enact its agenda. As a result, many investors have become more cautious.
Where does the stock market go from here? No one knows the answer to that. But if you think the economy is not going to justify stocks’ run-up, here are three strategies — ranging from conservative to aggressive — to weather a potential end of the market’s Trump rally.
1. Stay the course
This conservative strategy is probably the most intelligent. Continue to invest and don’t worry too much about how today’s headlines will affect your portfolio. Focus on the long term and realize that where the market goes this year has little impact on what your portfolio will look like in 10, 15 or 20 years. In fact, if the market goes down, your portfolio will probably look better then, since you’ll be buying when stocks are down, which is the best time for long-term gains.
This is the easiest strategy to implement, and your focus on the long term means regular investments will allow you to score a deal on stocks if they do fall.
Ease of strategy: Very easy.
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2. Reduce your stock purchases
This middle-ground strategy lets you keep investing regularly but reduce your allocation to more volatile stocks until the market moves lower. Cut your stock purchases by 50%, say, and keep the other half as cash in your account.
In an individual retirement account or a taxable account, leave some of your monthly contribution in cash. In a 401(k) program, you’ll want to continue piling up any employer match, so keep your contribution the same but reduce the stock allocation and move a portion into a money-market fund, which is safe.
When the market falls, increase your allocation again, moving cash and money-market accounts back into stocks.
The danger of this strategy is that if and when the market falls, you might be too afraid to restart your stock purchases and may continue waiting on stocks to plunge, missing out on long-term gains. You’ll also have to monitor the market more closely to determine when to start buying or to readjust your 401(k) allocation to buy more stocks.
Ease of strategy: Medium.
3. Buy put options
This strategy is the most aggressive and the riskiest of the three, and you actually have to invest some money to establish a position. Nevertheless, the strategy can return a lot of profit — think 100% or more — if you’re right.
It involves options trading and buying a put on a stock or index that you expect to decline soon. A put option gives the buyer the right to sell a stock at a predetermined, fixed price — the strike price — at a specific date in the future. If by that future date the stock finishes below the strike price, the put is “in the money,” and you collect the difference between the stock price and the strike price. If the stock finishes above the strike price, the put expires worthless. So options are often a high-risk, high-reward strategy.
Ease of strategy: Medium-hard to hard.
Let’s run through a quick example to see how it works. Imagine a stock trading at $22 a share. You’re able to buy a put contract at a $20 strike price that expires in three months. That put costs $1 per share, and each contract represents 100 shares of the underlying stock, so the $1 put contract in total costs $100.
Here’s how this could play out:
- The stock falls to $18 at the end of the three months, and the option is worth $2 per share, or $200 total. As a result, you make $100.
- The stock drops to $19, and the option is worth $1 per share, or $100, the same as its purchase price. You break even.
- The stock stays above $20 per share, and the put expires worthless. But you’re out $100 for the cost of the put contract.
Yes, the potential upside is great, but so is the downside. Not only do you have to be correct that the stock is going to fall, but the time frame has to be correct, too. That’s a huge challenge for even great investors. The good news is that options come in many different forms, including lower-risk varieties.
Whether or not the Trump rally ends, it’s important to consider all your investment options. For those with a long time horizon and steady nerves, doing nothing may well prove to be the best choice. Above all, invest based on facts, not your politics.
Jim Royal is a staff writer at NerdWallet, a personal finance website. Email: [email protected].