Investors are getting more excited about the stock market now that it has fully recovered from the financial crisis and started to set new record highs. But if you're looking to invest now, you have to protect yourself from the possibility that the long bull market could reverse itself.
It's always tough both financially and psychologically to recover from immediate losses on investments you just bought, so taking steps to avoid big losses is well worth the effort.
With that goal in mind, here are five exchange-traded funds that can strengthen your portfolio against the threat of a possible stock-market decline while still giving you exposure to further gains if the bull market continues.
iShares MSCI USA Minimum Volatility (USMV)
This ETF seeks out stocks that tend to rise and fall more gently than the overall stock market. With a concentration on health-care stocks like Eli Lilly & Co. (LLY) and consumer-oriented stocks like cereal giant General Mills Inc. (GIS), the iShares ETF focuses on stocks with defensive characteristics that hold up well under any economic environment. That won't keep the fund from losing money in a falling stock market, but it should help reduce the extent of your losses. And with low costs of just 0.15 percent annually, the ETF doesn't charge a ton to give you that protection.
PowerShares S&P 500 Low Volatility (SPLV)
Like the iShares ETF above, this fund focuses on low-volatility stocks in defensive industries. But the mix of investments in the PowerShares ETF is different, as it concentrates largely on utility stocks, which make up more than 30 percent of the fund's portfolio right now. Utility giants Southern Co. (SO) and Consolidated Edison Inc. (ED) provide strong dividend income, and their ability to rely on regulated income from millions of utility customers gives them security even when the economy starts to falter. The fund's costs of 0.25 percent per year are a bit higher than the iShares ETF but are still reasonable for ETFs generally.
PowerShares S&P 500 BuyWrite (PBP)
At first glance, this ETF looks a lot like a typical index-tracking fund, owning Apple Inc. (AAPL), ExxonMobil Corp. (XOM), and many of the other big companies in the S&P 500. But the twist this ETF uses is to write covered call options against that stock, boosting income at the expense of giving up some of the upside in its stock holdings. During bull markets, that strategy underperforms the overall market, but it produces more favorable results when stocks decline. With expenses of 0.75 percent, the strategy is a bit pricey, but it's still an interesting way to protect against the full impact of a downturn.
iShares S&P Preferred (PFF)
Stocks come in two flavors: common and preferred. This ETF focuses on the latter, as preferred stock traditionally produces more income with less volatility, acting less like regular stock and more like bonds and other fixed-income investments. Preferred stock still has risk, particularly from interest-rate changes as prices tend to fall when rates rise, and the iShares ETF has substantial exposure to financial companies. Still, with a yield of nearly 6 percent over the past 12 months, the ETF gives income investors the protection and dividends they want.
Vanguard Dividend Appreciation (VIG)
Most income investors seek out stocks that pay the highest yields they can find. But as defensive plays, stocks with long track records of increasing dividends steadily and consistently behave much better during bear markets, as they have the capacity to keep making their payouts even in tough times. The Vanguard ETF comes with rock-bottom expenses of 0.13 percent per year, and while its yield of around 2.2 percent doesn't stand up to more yield-focused investments, its protective capacity is very valuable in the current market environment.
Don't let record highs for the stock market keep you from investing, but don't be foolhardy with your investments either. These five ETFs have favorable characteristics that you should consider for your portfolio right now.
Motley Fool contributor Dan Caplinger owns shares of Apple and Vanguard Dividend Appreciation ETF. The Motley Fool recommends Apple and Southern Company. The Motley Fool owns shares of Apple. You can try any of our newsletter services free for 30 days.
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