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Assume that I'm being very pessimistic and that I'm assuming that the stock market rush leading up to the 1928 crash is a predictor of a similar major "correction" coming for the current 2018 market.

I have a 50/50 mix of low-fee mutual funds and higher-risk index funds (in a few 403b accounts) that are doing in sum about 1% better than inflation, even with the current gains in the stock market.

I have about 10-15 years left to invest, so a crash that takes that long to recover value to 2018 values in ~2035 (assuming a similar economic depression is coming) would adversely impact my ability to retire.

What class of investments can I move to in 2018, in order to protect their value as well as I can from and during a potential and extended global economic "correction"?

(Note: I'm not looking to debate or ask about whether the future is predictable, but simply asking how one invests in that hypothetical scenario. Thanks for understanding in advance the terms of this question!)

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    "low-fee mutual funds and higher-risk index funds*" Those are not opposite terms. It is, in fact, quite possible to have money in low-fee, high-risk indexed mutual funds. – RonJohn Jan 17 '18 at 21:14
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    No crash has taken more than 8 years to recover when adjusted for inflation/deflation. – D Stanley Jan 17 '18 at 21:26
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    I'm curious what you have invested in that is only doing 1% better than inflation right now. VOO for example has a +13% AAV 3 year return (so, over 10% better than inflation). Most other broad index funds are doing similarly - hence the "spike" that you're concerned about, among other things. Doesn't seem reasonable that you're only 1% better than inflation unless you really are lousy at picking index funds... – Joe Jan 17 '18 at 21:54
  • I really don't want to read someone's extended argument about how the future can't be predicted, and then get sarcastic, useless answers in addition. Please feel free to just answer the question, flag it for deletion, or just move on. – Alex Reynolds Jan 18 '18 at 5:37
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but simply asking how one invests in that hypothetical scenario. Thanks for understanding in advance the terms of this question!

Because you explicitly asked about this scenario, and explicitly don't want answers about any other: the best place to be if you think that the markets are a big, fat, highly margined bubble is, obviously, cash. That's because everything will crash in a 1928 scenario: equities, bonds, real estate, etc.

EDIT: forgot to mention the lack of FDIC in 1928. There haven't been many bank runs in the US since then.

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    +1 Depending on how bad the crash is, one might also consider canned food and ammunition. – Patrick87 Jan 17 '18 at 21:29
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    Also @RonJohn: read up on the Dust Bowl. Although I think Patrick is suggesting a crash that actually destabilizes the US civilization, rather than simply a monetary crash. – Joe Jan 17 '18 at 21:56
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    @Joe this is a technically accurate answer because he explicitly specified "hypothetical scenario". My portfolio is certainly not 100% cash, because "the market" is nowhere near the same as it was in 1928. – RonJohn Jan 17 '18 at 21:59
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    I agree it's technically accurate. I think it's a poor suggestion though, and thus downvote. I think we try to give good suggestions overall here along with a technically accurate answer, and I think the above question is really asking "what should I be doing with my investments so I don't get killed in a crash". – Joe Jan 17 '18 at 22:17
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    @Joe a couple of quotes from the Question: #1 "I'm not looking to debate or ask about whether the future is predictable" #2 "Thanks for understanding in advance the terms of this question!" To give any other answer than mine is Not Answering The Question. The proper course of action for you to take is to down vote the Question or flag it as opinion based. – RonJohn Jan 17 '18 at 22:31
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It depends on how soon you think this crash might happen. If it is more than a couple years away, I would say stay away from just keeping cash because this is the lowest-value use for your money.

I have a 50/50 mix of low-fee mutual funds and higher-risk index funds

I'm assuming you mean 50% in low-risk mutual funds and 50% in high-risk index funds. The easy answer is to lower your exposure to market risk by decreasing holdings in your higher risk assets. Consider divesting into stable vehicles such as bonds, or firms with low beta that are expected to do well, or at least hold value during economic downturns.

You may also want to consider buying foreign stocks or currency to protect against the US market. During the 2008 economic crisis, CAD and EUR were fairly stable and gained a lot of value against the USD. Markets outside the US (while they did react) were not so volatile and recovered much more quickly.

If you think a crash is imminent (as in within the current year) then you want to make sure your money is in a federally insured bank and savings account, where it can earn a small amount of interest until you want to pull it out.

Hope this helps you!

  • OP is hypothesizing that a 1929-style crash is coming, not a 2008-style crash. – RonJohn Jan 17 '18 at 22:37
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    I know that, but my point is that diversifying outside domestic markets is a way of decreasing exposure to US economic crises. – Michael Hartmann Jan 17 '18 at 23:06
  • I've been trying, with no luck, to find info on foreign stock markets in 1929 and 1930. – RonJohn Jan 17 '18 at 23:11
  • Yeah I did a bit of googling myself and couldn't find much, but I'm assuming that since the world was much less interconnected and markets were not linked as they may be now, (foreign companies registered in US and multiple listings across markets) the impact would be buffered by that gap. That's my logic there, and I used my knowledge of the 2008 crash to maybe offer some evidence of this. – Michael Hartmann Jan 18 '18 at 3:02
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Much of the exact answer to your question lies in how much money you have now relative to what you'll need to retire, and in how much ability to contribute you will have.

To start with, you should be in a moderately safe investment portfolio now regardless of your opinion on the market. Vanguard's Target 2030 retirement fund, for example, has a 75% Stock 25% Bond allocation. That's moderately safe, in that a crash will certainly hurt it but the 25% Bond allocation will protect it from the worst of the crash, and still gains fairly well - 3 year return on the fund is around 8%, or 5-6% higher than inflation.

Your current rate of return is alarming to me: the US inflation year-over-year rate right now is around 2%. So if you're only beating that by 1%, then you're only getting 3%. Most of Vanguard's bond funds do better than that, not to mention stocks; even government bond funds usually beat that. A 20 year t-bill right now earns 2.7% or so. If you're barely beating t-bills, then you've made some interesting choices or don't understand your return rate. Consider getting into some more basic ETFs, or even simply investing in a target date fund like the above Target 2030 fund (all major brokers offer something similar).

If you have most of what you need to retire, meaning a 1% to 2% annual gain will be sufficient to get you to where you need in addition to your additional savings in those 10-15 years, then you can play it even safer: cut back your exposure to the stock market some, invest more in government bonds and other 'truly safe' investments. Say 50% Stock, 25% broad Bond, 25% Government Bonds. Those government bonds are close to cash in terms of safety - they won't lose a ton of value even in a crash, and in fact probably will gain value in a true crash. They won't do much more than inflation, though, so they shouldn't be heavily invested in until you're close to retirement.

If you're not close to your full retirement account right now, but you do have a strong ability to contribute over the remaining 10-15 years, you should stick with the more traditional recommendation (75% stock 25% bond), and recognize that you'll actually be in a good position if there's a crash in the next few years. That's because you'll have a window to buy stocks while they're very low, and then ride the gains up for the remaining decade. No crash has taken more than a decade to recover value, so your actual stock holdings (as long as they're broad funds and not specific stocks) will recover by retirement, and your new purchases will do better than that. And in addition, if you rebalance using your bond holding you'll be able to similarly take advantage.

If you won't have much ability to contribute (as are some people in their 50s now who lost their jobs during the last recession, and are now underemployed and unlikely to improve), and are not in a good situation yet retirement-wise, you're going to decide between accepting the risk (for the larger gains), and going with the much safer strategy but likely taking longer to be able to retire (unless you're right about a very imminent crash). I would encourage you not to assume you can time the crash; if it were likely we were about to crash, the market would be going down, not up. Investors much smarter than either of us are taking all of the above information into account, and yet still are buying stocks.

  • What's odd is that I get a summary letter from my retirement fund manager saying that the total return over the year for index fund A is, say, 4.4% (so 1.3% better than 3% inflation), while the current-year performance listed on the investment company's website for index fund A is around 12.3%. I don't really understand the discrepancy between what my fund manager reports and what the company's site reports, which is why I'm looking at moving things into the low-fee mutual funds, which don't seem to have these discrepancies. – Alex Reynolds Jan 17 '18 at 22:23
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    @AlexReynolds That discrepancy – which seems to be your underlying problem – might be worth its own question. – TripeHound Jan 18 '18 at 12:48
  • @AlexReynolds Definitely look into that. And note that inflation is 2% right now, not 3%. – Joe Jan 18 '18 at 15:48
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There are different approaches to protecting profits and reducing your losses in a bear market and they offer varying degrees of protection. Some will even make you money.

First, you have to differentiate between a crash and a bear market. 1929 and 1987 were crashes. Unless you had some form of negative correlation protection in place prior to them, you paid the piper. Bear markets like 2000 and 2008 took 18 months to unfold so they offered lots of time to react and adjust.

The buy & hold types recommend diversification and reallocation. AFAIC, that's just a way to spread the losses across various sectors, hoping that some don't lose as much as others. But you will lose. Would you consider losing 30% in 2000 or 2008 being protected when the market lost 50+ pct?

Some will recommend gold. Sometimes gold correlates, sometimes it does not. It's an iffy proposition for protection.

Some will recommend bonds. Like gold, they don't always move inversely to the market and given our historically recent years of low rates, they may again correlate with the market (both go down).

Some will recommend stop loss orders. That's fine in a correction but in a crash, you have no clue where the fill will be if price gaps through your stop loss price. Again, iffy.

You could write covered calls but that provides only limited downside protection and if your stocks crater, you won't be able to continue doing so without locking in a loss.

Others will recommend buying puts. That offers several problems. Even at the current level of implied volatility, portfolio hedging might cost 5–6 pct a year, depending on the index. That's an awful lot of portfolio drag to overcome if the market stagnates or moves up modestly. You can reduce put protection cost if you use OTM puts but that adds a 'deductible' to the put cost which is the loss from current price down to the put's strike price. If you buy puts and the market moves up, the additional gain is not protected.

If you are comfortable with giving away much of the upside potential gain, you can reduce/eliminate the put cost by collaring long stock. Sell OTM covered calls to fund the cost of the protective puts. Note that collared long stock is synthetically equivalent to a bullish vertical spread. Verticals have a limited a R/R profile.

There are other sophisticated approaches:

1) Buy inverse ETFs

2) Run a long/short portfolio

3) Short stocks, ETFs and futures

AFAIK, no one can predict when a market will crash or correct significantly. Many will guess and a few will be correct. The wiser approach is to recognize that severe market downturns such as the 2000 Dotcom Bust and the 2008 subprime melt down did not happen overnight. For those who aren't oblivious, along the way it becomes obvious that market metric are deteriorating - economic indicators turn down, earnings announcement disappointments increase, analyst downgrades and earnings revisions increase, the VIX increases, all beginning long before the crisis becomes acute. React, don’t predict.

Transitioning to cash or quality debt is something that any investor can achieve. If god forbid one takes off the 'long only' tunnel vision blinders, one can even go short a small position and transition to more short as the market drops further. Let your portfolio’s declining value dictate the transition from long to short (and vice versa).

My vote for the average Joe investor is to collar your overvalued positions. You'll still have some upside potential but you won't get hammered if there's a large correction. If your collars are 2–3 months out, if the underlying cooperates and appreciates toward the short call strike, you’ll be able to roll your collar up, locking in the appreciation and raising the level of protection.

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