Financial markets often are directly correlated to the macroeconomic, social and political factors far out of our control. Herds of investors are prone to reacting in extremes whenever these macro factors exhibit sudden change.

The coronavirus shutdowns are a prime example. But the same factors — fear, panic, herd mentality — drove the declines in 2008 and before.

Experience shows that most people simply do not have the required temperament or risk appetite to hold their investments through short-term market shocks.

To avoid getting gored, focus instead on owning a collection of investments that create a “firewall” against extreme market shocks and can ensure that your savings remains preserved in difficult times yet thrives in good times. 

Do invest your money

If you are going to need your money in the short term you should keep it in cash. If you are planning to fund your kid’s college education a year from now or you are looking to move out of your rented place and make the down payment of your new home in the near future, keep those funds in a savings account or in a money market fund. Stock markets are not the place for you.

If you will be needing money over the next five years you should consider secure, income-generating investments, such as bonds, certificates of deposits (CDs), and Treasuries. Treasury notes and bills are the safest, while CDs are very safe too provided they are insured by the FDIC. (Most are.)

Corporate bonds are relatively risky compared to bank deposits but will provide a better yield. If you are going to invest less than $30,000, a prudent way could be to own a bond mutual fund as an individual investor. Carefully consider your risk-reward profile while choosing between these investment options.

If you are not going to need your money for a period of at least five or more years, invest in the stock market. From 1926 to 2007 the average annual return on investments in large-cap stocks has been 10.4%. You cannot expect to earn anywhere near this kind of return from Treasury bills, government bonds or high quality corporate bonds. And you’ll need a higher return to stave off the effects of inflation on your cash.

Stay invested

The key here is that you will make money in the stock markets only if you can stay invested in it for the long haul. The earlier you begin investing in the stock markets, the greater will be your long-term returns as the power of compounding works for you.

Even if you are nearing your retirement you should still consider investing a part of your funds in good quality stocks for the long-term. After all, the average American’s lifespan, according to the CDC, is 78.6 years. This means that even if you are 50 today, on average you still have nearly three decades more to live.

Seasoned investors know that there is no surefire winning investment and that the future is unpredictable. If you are not a market veteran and you want to shock-proof your investment portfolio, put the biggest chunk of your savings in index funds and established dividend stocks. This will eliminate the role of guesswork and intuition and help ensure that your capital is preserved and thriving for the long run.

Beating the stock market consistently over a long period of time is an extraordinary feat, one which only a few investors in history have managed to achieve. In the final analysis, you will be much better off if you invest in index funds linked to a broad market index such as the S&P 500. You will not outperform the market with this strategy, but you will also not get decimated either.

Some of the most time-tested, highly respectable companies with global brand domination have an outstanding track record of producing profits consistently and paying solid dividends. If you do not wish to focus on capital gains alone and want to create a regular income stream, invest in dividend-paying stocks of companies with a reputation for dependability.

Diversify, and own more than just stocks

If you believe that diversification is a better strategy for shock-proof asset allocation, make sure you invest not only in different asset classes, but also diversify within each asset category.

For instance, if index funds don’t inspire you much, choose individual stocks across multiple industries and sectors to minimize the impact of market volatility. Different sectors will perform differently under certain market conditions.

For example, technology stocks such as Apple, Google, and Facebook have grown dramatically during the recent bull market, while consumer goods, healthcare and defense sector stocks are likely to do better during a bear market.

Many people make the mistake of assuming that investing in bonds does not require a careful diversification strategy. If you are invested in corporate bonds only, consider allocating a part of your investments to municipal bonds and Treasury securities.

It may be prudent to make staggered investments so that your bond maturities occur at different times. This will allow you more flexibility to react to a fluctuating interest rate environment.

Consider alternative investments

While stocks and bonds are essential to most balanced investment portfolios, consider allocating a part of your funds toward alternative investments. The non-traditional investments can outperform most other asset class in certain market conditions.

Gold and other precious metals are an all-weather alternative investment which can do particularly well when economic uncertainties are at their peak. Investment in renewable energy companies is another option you can consider. If real estate appeals to you, real estate investment trusts (REITs) or a direct investment in a rental income property present a promising opportunity.

When you diversify your investments across multiple asset categories and multiple assets within each category, you position your portfolio for greater stability when the markets go through periods of extreme shocks. With diversification you can continue to maximize your advantage, no matter what the prevailing market conditions may be.

Spread your risks and avoid putting all your eggs in a single basket. Remember Warren Buffett’s advice: “Rule number one: Never lose money. Rule number two: Never forget rule number one.”