The strategic investor’s guide to building a resilient portfolio

You’ve mastered the basics of investing, like stocks, bonds, and retirement accounts. Now you’re ready to take your investment strategy to the next level and create a portfolio that can conquer whatever the market brings.

Discover powerful ways to boost your flexibility, including asset diversification, tax optimization, and ETF investing.

Why portfolio resistance matters

If history has proven anything about investing, it’s that volatility is a given when holding stocks. The market as a whole has generated strong returns on average for a long time, but fluctuations from year to year can be highly unpredictable.

This uncertainty can be nerve-wracking, especially during extended recessions, but fluctuations are completely normal. The real risk is that it will cause you to deviate from your investment strategy, lock in your losses, and miss out on a potential recovery.

Building a more resilient portfolio is one of the best ways to help prevent this outcome. By limiting losses in downturns, you not only protect your gains – which can improve returns over the long term – but also avoid stress that can lead to emotional decision-making.

“Being a resilient investor is all about staying invested during market downturns,” said Daniel Schumper, CFP, senior associate wealth manager at Fairway Wealth Management.

“This gives investments time to recover, avoiding realized losses. Most importantly, it eliminates the need for timing reinvestments. Investors who sell in panic often wait for the ‘right’ time to return and miss the subsequent recovery, which can impact long-term returns.”

Explore your asset options

Stocks often make up the largest portion of investment portfolios in the United States. According to the latest Gallup data, 62% of Americans own stocks, either individually or through some type of fund.

But while stocks can be powerful engines of growth, a 100% stock portfolio is unlikely to be the most resilient. If you want to mitigate the effects of market volatility, diversification into other asset classes is often necessary.

“Investors should consider expanding beyond stocks once their portfolio reaches a level where preserving capital becomes as important as growing it,” said Jamie Duggan, CFA, portfolio manager at Crestwood Advisors.

“Early in wealth building, investing in stocks makes sense because an investor’s greatest asset is time. But as wealth continues to grow, or as income needs and specific goals arise — such as purchasing a home — diversification becomes critical.”

Here are some common asset classes that can complement stocks in a portfolio:

• Bonds: Provide stability and predictable income flow. They often move differently than stocks, which can dampen overall portfolio performance in downturns.
• Real Estate: Provides the potential for cash flow and capital appreciation. Leverage and industry experience may allow you to achieve significant returns.
• Alternatives: Refers to asset classes such as private credit and private equity. It can provide exposure to unique opportunities unrelated to the general markets, although it may come with higher risks.

“Allocating to multiple asset classes reduces the likelihood of needing to sell an investment at a loss when cash is needed,” Schomper said. “It also helps avoid panic when a particular asset class, sector or individual security experiences a significant pullback, as the rest of the portfolio acts as a buoy to stabilize overall returns.”

Use ETFs as building blocks

Exchange-traded funds (ETFs) are a type of investment fund that holds multiple underlying assets, such as stocks, bonds, or commodities. They can provide broad diversification within a single investment, often at a very low expense ratio. As a result, they often make useful tools when building a flexible portfolio.

ETFs are similar to mutual funds, but you can trade ETFs on an exchange throughout the day, like individual stocks. Historically, ETFs have also tended to offer lower fees, lower investment minimums, and greater tax efficiency. However, their traits can vary greatly between species.

Here are some of the most notable differences in ETFs:

• Passive ETFs: These automatically follow a pre-defined set of investment rules, and require little or no active management.
• Actively Managed ETFs: Active ETFs are run by professionals who buy and sell properties, trying to outperform the benchmarks.
• ETFs: These are passive ETFs designed to track a specific market index, such as the S&P 500.
• Sector ETFs: Also known as industry ETFs, these passive funds invest in stocks within a specific economic sector, such as technology or healthcare.
• Dividend ETFs: These companies invest in stocks that have a history of paying regular, and often increasing, dividends to shareholders.

“Using ETFs in the core of the portfolio can help investors stay the course,” Schomper said. “Because they provide exposure to a clearly defined sector of the market, investors know what to expect from them in different market environments.”

Sharpen your strategy

An investment strategy is not something you set and then forget, no matter how confident you are in it. Over time, your personal and financial circumstances inevitably change. To keep your investment portfolio flexible, it’s important to review your plan at least once a year and after major life events, such as getting married or having a child.

Often, you’ll only need to make minor adjustments, such as rebalancing to maintain your asset allocation. But sometimes, you may need to make more important updates, such as rethinking your choice of investment vehicle. For example, you can change from a mutual fund to an exchange-traded fund (ETF) if you can find an equivalent fund with a lower expense ratio.

However, if you feel confident in your basic investment strategy, you may want to try more advanced and riskier approaches using a small percentage of your investment portfolio.

In this case, derivatives may be worth investigating, such as options, futures and swaps. They are financial contracts between two or more parties whose value is derived from an underlying asset or group of assets.

“Financial derivatives can dramatically amplify the upside and downside potential, while also changing the potential for each,” said Shawn Sun, managing partner at Maridea Wealth Management. “Imagine a game where you have a 50-50 chance of losing 100% on a coin flip but getting 1,000% on a coin flip. You might want to play this game until the end of time.”

However, while financial derivatives offer new opportunities, they also come with complex risks. Be careful not to let them undermine the resilience you are trying to build. “Derivatives can be powerful tools, but using them effectively requires deep knowledge and disciplined implementation,” Sun said.

Make smart tax moves

Following an efficient tax strategy is another key part of building a resilient portfolio, and the foundation of tax efficiency is asset location. This refers to the account you invest in, such as a 401(k), individual retirement account (IRA), or taxable brokerage account.

The order in which you fund these accounts — and how much you contribute to each — has a big impact on the amount of taxes you pay over the course of your life.

“As for ranking contributions, I typically recommend prioritizing a 401(k) and an HSA,” said Evan Longo, founder of NoDa Wealth. “With a 401(k), at a minimum, you should contribute enough to get your full employer match. An HSA is powerful because of its triple tax benefits. After that, the next step depends on the goals.”

As your investment portfolio becomes more complex, you may also consider more active strategies. One of the most common of these methods is tax loss harvesting, which involves selling investments at a loss to offset gains or ordinary income. You typically reinvest the money in similar — but not identical — assets to maintain your target exposure without triggering a wash sale.

“We typically offer tax loss harvesting once a client builds a taxable account large enough that realized losses can offset large gains or ordinary income,” Duggan said. “A good time is often during major market fluctuations, when losses are most apparent.”

Stay strategic, not reactive

Although portfolio flexibility is important, it is not sufficient in itself. No portfolio is immune to volatility, so you must also cultivate a long-term mindset. Understand that the ups and downs are part of the process and commit to investing through them.

“Market volatility is a cost of admission for investors who want long-term growth,” Longo said. “It never sounds comfortable, but decades of data show two things: (1) volatility is normal, and (2) markets recover, usually to higher levels than before.”

Emotional reactions can undermine even the best investment strategy. Be patient, avoid the temptation to chase trends, and adjust your strategy only when there is a logical reason to do so. If you’re having trouble maintaining perspective, consider working with a financial advisor.

“I’m a nervous pilot, so when I get into turbulence, I like to watch videos of the plane’s wings undergoing a pressure test, where they bend almost vertically before they finally fail,” Sun said. “It reminds me how flexible this flying piece of metal is.”

“I think about market volatility the same way. Anytime we see red in our portfolios, we ask ourselves, have the fundamentals changed? Have the underlying thesis changed? If not, the wings are still holding and we will remain committed.”

Bottom line

Building a resilient portfolio means limiting losses in downturns to improve returns and reduce stress. You can achieve this through tactics such as diversifying across asset classes, leveraging ETFs, avoiding taxes, and reevaluating regularly. Combined with a long-term investing mindset, you’ll be well-equipped for weather market cycles.