Feeling queasy? After soaring for more than six months, stocks have started to wobble lately. Despite the recent indigestion, stocks remain way above their March 9 lows. The Dow industrials ($INDU) this week were more than 60% above their nadir, while the Standard & Poor’s 500 Index ($INX) and the technology-happy Nasdaq Composite Index ($COMPX) were up about 70%. 
How to rebalance your portfolio
Clearly, stocks could not continue to rise indefinitely at their earlier pace, and some would argue that a correction is not only inevitable but also healthy. So maybe the Dow will drop a few hundred more points and then resume its ascent.
But what if things get worse first?
What if the recovery proves to be shallow or stalls? Worse still, what if the economy falls back into recession? What if another major financial company fails? Stocks could quickly lose 25% of their value, as they did in the first 10 weeks of 2009.
Video: Can we trust this rally?
Are you prepared? Here are seven ways to protect your recent investment gains from a sudden reversal in fortune. We list them in order of increasing complexity.
Strategy No. 1: Raise cash
Boosting your cash holdings is one obvious way to make your portfolio less vulnerable to a market collapse. Of course, you can arbitrarily decide that you’ll sell, say, 30% of your stock holdings and move the proceeds into cash (money market funds, checking accounts, Treasury bills and the like). But there’s no need to make such a drastic move.
There are a lot of ways to increase cash without incurring unnecessary costs or missing out on opportunities. Here are three:
- If you’re rebalancing (see Strategy No. 2), sell some of your winners but keep some of the money in cash rather than buy laggards.
- If you make regular contributions from your paycheck to a 401k or other retirement plan, continue to do so but direct the new contributions to a cash account rather than to stock or bond funds.
- If you own dividend-paying stocks, direct the payouts to your cash account rather than having them reinvested in new shares. The same goes for distributions from stock funds.
Strategy No. 2: Rebalance
If you own a lot of stocks and funds that have notched big gains this year, chances are you no longer have the mix of assets you once thought was ideal. Now would be a good time to sell some of your big gainers and put the money into assets that haven’t done as well.
You should rebalance your portfolio in this manner at least once a year — more often if big market gains or losses leave your portfolio far from your desired mix. Rebalancing forces you to sell high and buy low (or at least to sell outperformers and buy laggards) — an ideal way to preserve investment gains and set up your portfolio for further success.
Strategy No. 3: Buy low-beta stocks and funds
Beta is a term that describes a stock’s tendency to move in tandem with a particular market index, which by definition has a beta of 1. If the index gains 1% during a given period, a high-beta stock would gain more, on average, and a low-beta stock would gain less.
High-beta stocks such as Apple (AAPL, news, msgs), which has a beta of 1.49 relative to the S&P 500 Index, have done particularly well during the recent rally. Low-beta stocks are likely to hold up better if the market heads south.
We screened for stocks with betas of 0.6 or less relative to the S&P 500 and turned up a number of safe, dividend-paying giants, such as Monsanto (MON, news, msgs), Novartis (NVS, news, msgs) and Procter & Gamble (PG, news, msgs). You can find low-beta funds, too.
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A screen at Morningstar for diversified domestic-stock funds with betas of less than 0.8 turned up, among others, Vanguard Dividend Growth (VDIGX) and Forester Value (FVALX).
But if you want to buy a fund because of its low beta, make sure you first check out its holdings in the latest shareholder report or on the fund sponsor’s Web site. A low beta can indicate that a fund is holding a lot of cash or owns many stocks that aren’t in the S&P 500.
Strategy No. 4: Buy a hedged fund
Some low-cost mutual funds have adopted strategies long used by hedge funds without charging hedge funds’ exorbitant fees. These mutual funds use a variety of techniques to make themselves less vulnerable to the market’s declines while still capturing at least some of its gains. If done correctly, these techniques, which can include the use of options, futures and short-selling, can be carried out with relatively low levels of risk.
Among our favorites: Hussman Strategic Growth (HSGFX), a growth stock fund that uses options and futures to hedge its market exposure during times of uncertainty; Arbitrage Fund (ARBFX), which specializes in buying shares of companies targeted for acquisition by other companies; and TFS Market Neutral (TFSMX), which holds a combination of long and short stock positions designed to neutralize most of its exposure to the market’s day-to-day movements.
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