If you're worried about a big stock market drop, please read today's issue carefully.
Below, we share a simple – yet extremely powerful – idea that could save your portfolio from the next market crash. Despite its power, many folks get it all wrong. They end up making mistakes that can set them back years... even decades.
Longtime readers know we urge investors to think about risk a lot more than reward. Risk is always the No. 1 focus of professional investors... But amateur investors tend to think only about how much money they can make.
That's why, if you want to make outstanding investment returns over the long term, you need to take care of the downside. And one of the ultimate ways to take care of the downside is to avoid huge bets in one single sector...
An amazing story from the 2000-2002 stock market crash shows us how it works...
Imagine you were investing in the late 1990s. Like most folks back then, you were watching Internet stocks soar. Then in 1998, you started buying some of the top-performing names in the sector. You were making a killing... So you kept at it until nearly your entire portfolio was allocated to technology stocks.
Lots of smart people got sucked into the trap. When the tech bubble burst in 2000, the S&P 500 Information Technology Sector Index – which housed a lot of the popular tech names – dropped 83%. It still hasn't surpassed its old highs.
This was a so-called "diversified" index... not just a few bad apples. But the stocks in the index are highly correlated. When one falls, they all fall. It would have turned a $100,000 account into just $17,000 in two and a half years. This kind of loss would take a 488% gain to recover from. As you can see, making that money back can easily take more than a decade.
But take a look at the returns of the 10 different industry groups of the S&P 500 over that same time frame. The rest of the market wasn't nearly as bad as the technology sector. Many other sectors – especially consumer staples – held up far better.
If you were holding 10% of your stocks in each of these 10 sectors, the crash would have resulted in a 33% drop instead of 83%... And your account would have fully recovered within two years.
This idea of owning stocks in different sectors ties in with the bigger idea of
asset allocation. Just as it's important to hold different types of stocks, it's even more important to spread your wealth among different asset classes... like bonds, gold, real estate, and cash.
In the case of an all-out financial storm (like many are predicting right now), this will prevent catastrophe.
Let's take another look at that 2000-2002 time frame. In the chart below, you can see how other asset classes performed while tech stocks were crushed and the stock market in general (the S&P 500 Index) struggled.
The moral of the story: Own stocks... But own stocks in different market sectors. And don't keep all of your money in stocks. Holding gold, bonds, and other assets goes a long way toward protecting your wealth.
It's the simple way to survive the next market crash. It has worked in the past... and it will very likely work again.