The S&P/ASX 200 Index (ASX: XJO) has fallen more than 20% since investors started worrying about the economic effects of the coronavirus outbreak. You could definitely say we're in a bear market now.
Investors want to know how to protect wealth in light of these declines. What is the answer?
There are a few hedges that people like to use such as gold, bonds or utilising options – which can be done by the individual investor or by specifically-designed exchanged-traded funds (ETFs) like BetaShares Australian Equities Bear Hedge Fund (ASX: BEAR) that are designed to go up when markets go down.
But I don't really like the above options. They generally have a management cost to own, and gold & hedged ETFs go down when the markets go up. Markets rise most years, so they'd be a drain on your returns in most years. No-one can truly predict when markets will go down. Bonds aren't bad, but they have fallen during this volatility and offer lower returns than shares over the long-term.
When would you decide to buy these potential hedging ideas? And when would you sell them to switch into shares? You could end up holding on too long to see the value fall again. You're having to make two calls which you could get wrong.
So what are you supposed to do?
The thing is, there's going to be volatility every so often. That's why people say shares are 'risky'. The last decade has been largely plain sailing for the share market. It won't be calm 100% of the time.
The share market has returned 10% per annum including the bumps along the way.
You could protect your wealth by never investing in shares to begin with. Stick with cash. Then you'd never see your portfolio fall in value. But that would be very detrimental to your long-term wealth creation, particularly as inflation eats away at it and interest rates are now at all-time lows.
By trying to protect your wealth in the short-term you can end up causing a lot of pain to your portfolio in the long-term. You wouldn't sell your house or farm just because someone is offering a lower price for it this month.
I don't mind the idea of holding onto some cash whilst waiting for better opportunities to present themselves. Cash is a good short-term measure for protection and to buy those shares at discounted prices. But over the long-term, it's best to be invested in assets that can compound your wealth for you.
