Many investors are anxious over how the stock market can experience such euphoric growth even as the US economy remains on life support. Today’s sky-high stock valuations may be justified by a booming economic recovery in the next 12 to 24 months as the pandemic wanes. But if you’re worried that scenario may not play out smoothly and can’t stomach market drops, it’s time to “de-risk” your portfolio. Top financial adviser Ric Edelman told us how…

De-risking means reevaluating how much volatility you can handle in the short term—anywhere from six months to two years—then reducing your stock exposure and raising your cash holdings appropriately. How much should you de-risk? It depends on your particular situation, but enough so that you have the fortitude to avoid panicking and selling stocks during a scary pullback…and feel confident that you won’t be forced to liquidate stocks when they’re down just so that you can pay your bills.  

Three options I suggest to clients who plan to own stocks long-term (at least five years) but want extra protection for their portfolios now…

Trim the stock portion of your portfolio by at least 10%. While 10% doesn’t sound like it will make much of a difference in a stock market correction, if your portfolio is composed of 50% stocks/50% bonds, reducing your stock exposure to 40% lowers your overall risk by 20%. Steps to take: Sell some shares of your biggest winners or shares of your most aggressive stocks. In taxable accounts, you’ll need to keep capital gains taxes in mind, perhaps by selling losing stocks that you’re no longer enthusiastic about in order to offset some of your gains with capital losses. You can buy back positions of stocks you like when you feel the economy is on stronger footing or when their valuations look attractive again. 

Cash out a large portion—or even all—of your stock portfolio. Then dollar-cost average back in over the course of the next year. This is for investors who simply cannot stomach the stock market now. The strategy reduces your chances of big losses, but you’ll also miss big gains and potentially have a high tax bill, which is why it is best for tax-deferred retirement ­accounts. Steps to take: After you cash out, don’t try to time the market to get back in. Automatically reinvest one-twelfth of the money each month until you reach your original long-term asset allocation and have re-created the portfolio you sold off.   

Increase your emergency savings to cover at least two years of living expenses. I recommend this to many of my clients, but especially those in retirement. Retired investors find great resolve knowing that they won’t have to compromise their lifestyle or sell assets in the midst of a down market. Beef up your emergency savings by trimming 2020 winners and selling losers that you no longer want to own.  

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