One of the dangers of the ongoing trade war between the United States and China is the opportunity cost that investors are paying by pulling money out of the market. Many institutional investors are decreasing their exposure to equities. Once Wall Street starts to pull their money out of the market, Main Street won’t be far behind.
But is that the best strategy? If you’re a young investor, history is on your side. Over time, stocks will provide a better return than virtually any other asset class. Particularly when savings rates are still at historic lows and the bond market is proving to be every bit as volatile as equities. With that in mind, here are a few strategies for investing during the trade war that can help maximize your return while minimizing your risk.
Index Funds are a Safe Way to Spread the Risk
The goal of an index fund is to match or exceed the performance of its underlying index. Every index (such as the S&P 500 Index) uses different weighting methodologies to more accurately reflect the relative importance of different companies (called components) of the index. Index funds do not have to be tied to equities. Investors could decide to invest in an index fund that tracks commodities.
An index fund can be actively managed or passively managed. An actively managed fund is one in which the fund manager will attempt to beat the performance of the underlying index. For example, the T. Rowe Price Equity Index 500 Fund (PREIX) is an actively managed index fund that attempts to exceed the performance of the S&P 500 Index (which is its underlying index).
A passively managed index is one in which the fund manager will attempt to match the performance of the underlying index. They do this by matching the weighting that is assigned to the components in the underlying index. The Schwab S&P 500 Index Fund (SWPPX) is one such example.
In general, a passively managed fund will have a lower fee structure than an actively managed fund. Fees and expenses can play a large role in the total return of the fund.
Use Call or Put Options
A more advanced investing strategy that can be effective during the trade war is to use call options or put options. Options trades are financial contracts between a buyer and a seller. Many novice investors assume that trading options is risky. However, properly understood it’s one of the safest ways to invest.
In a call option, the owner of the option buys the right (but not the obligation) to purchase a specified number of shares at a specified price. If the buyer “calls” the option on the expiration date, the seller is obligated to sell the shares to the buyer at the agreed-upon price. If the stock price climbs above the call option price, the buyer of the option will most likely exercise the option and then trade their new shares at market value for a profit. However, if the stock price does not climb above the agreed-upon price, the buyer of the option can simply choose to let the option expire. In this case, the buyer of the option is only out the money he paid to purchase the option.
In a put option, the owner of the option is the seller. In this case, they are buying the right (but again, not the obligation) to sell the buyer a specified number of shares at a specified price. If the stock price falls below the agreed-upon price, the owner of the option may exercise his right. At this point, the buyer must purchase the seller’s shares at the agreed-upon price. In this way, the owner of the put profits from selling their shares above the current market value. If the stock price does not fall below the agreed-upon price, the owner of the option can simply choose to let the option expire. In this case, the seller is only out the money he paid to purchase the put option.
Look at REIT Stocks
Inflation remains contained which means now is a good time to look into real estate investment trusts (REITs). The advantage of these stocks is that they are required to pay out 90% of their profit as a dividend. Historically, four of the best performing categories are hotel REITs, apartment REITs, manufactured home REITs and self-storage REITs. These categories also tend to be less impacted by trade concerns. A good index fund option that gives investors exposure to these categories is the Nushares Short Term REIT ETF (NURE).
There is Risk in Any Market
As risky as it may seem to stay in the market, there is a risk to taking your money out of the market as well. The trade war between the U.S. and China does not affect all sectors and companies to the same degree. Index funds, options, and REIT stocks are just a few of your potential options. Domestic dividend-paying stocks are also a good alternative. Remember, right now your goal isn’t to get spectacular growth, but it’s to keep your money in areas where you’re at least making a gain. The trade war will eventually end, but until then it’s wise to take simple strategies to protect your wealth.