The S&P 500 is hovering near record highs, and valuations by some measures are historically high. Investors have several reasons-high inflation, high interest rates, geopolitical uncertainty, a mixed labor market-to be concerned about whether the next major market decline is nearing. It will arrive eventually. The problem is that nobody knows when.
The solution isn’t to radically alter your portfolio, move into cash, and wait it out until you feel more comfortable. That generally does more harm than good.
What you can do is tilt your portfolio toward a more defensive stance while maintaining the potential to continue capturing upside if prices keep rising. If I were particularly worried about a stock market crash today, here are three ETFs I’d use together.
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ETF No. 1: Vanguard S&P 500 ETF
It might sound strange to prepare for a crash by owning the very stocks that you’d want protection from. But owning the Vanguard Total Stock Market ETF (VTI -0.90%) isn’t about maximizing gains. It’s about serving as a core long-term foundational holding that you buy and hold regardless of short-term market conditions.
VTI still owns the S&P 500’s largest companies, including Nvidia, Microsoft, and Apple. Those stocks are closely tied to the artificial intelligence (AI) trade and could very well suffer substantial losses during a bear market.
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But history also suggests that abandoning stocks altogether creates an even bigger long-term problem. Investors who try to time the market more aggressively often end up lagging the major indexes over years and decades.
The Vanguard Total Stock Market ETF is meant to serve as the core long-term holding in a portfolio. Selling it to avoid a market correction that may or may not come can be damaging. This is the one ETF you’d want to hold onto regardless.
ETF No. 2: Vanguard Dividend Appreciation ETF
The Vanguard Dividend Appreciation ETF (VIG -1.13%) is where the real defensive positioning begins. It focuses on buying U.S. companies with long track records of dividend growth. Because of their dividend histories, they tend to be more mature, deliver stronger cash flows, and are better built to withstand different economic environments.
The top 10 holdings include names like Walmart, JPMorgan Chase, ExxonMobil, and Visa.
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The Vanguard Dividend Appreciation ETF still holds some of the big tech names, like Apple and Microsoft. But it’s much more well-balanced across many sectors rather than heavily dependent on just one.
The 1.5% yield won’t get many people excited, but that’s not the biggest benefit of holding it here. Its emphasis on financially healthy dividend growers can offer a different risk profile than simply investing in the S&P 500.
ETF No. 3: Vanguard Intermediate-Term Treasury ETF
Investing in Treasuries would be a more effective bear-market hedge. They often rise when stocks fall because investors seek out safety in volatile markets.
The Vanguard Intermediate-Term Treasury ETF (VGIT -0.26%) invests in government bonds with maturities of between three and 10 years. In this scenario, this is about as aggressive as I’d feel comfortable getting.
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Vanguard Scottsdale Funds – Vanguard Intermediate-Term Treasury ETF
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While there’s the potential for gains, I’m more concerned about inflation and interest rates. When these rise, bond yields often rise as well, causing Treasuries to decline. We saw this happen in 2022 when the Fed’s aggressive rate-hiking cycle caused bond and stock prices to fall together in an uncharacteristic fashion.
But if inflation and interest rates are peaking here, there’s a stronger upside argument for Treasuries. If you want a little more safety, the Vanguard Short-Term Treasury ETF (VGSH -0.03%) could serve as a better option.
What if the crash never happens?
A generic allocation for these three funds together might look something like 50% to the Vanguard Total Stock Market ETF, 25% to the Vanguard Dividend Appreciation ETF, and 25% to the Vanguard Intermediate-Term Treasury ETF.
But while this mix is likely to provide some protection in a bear market, it’s important to consider the downside risk of such a shift. If the bull market continues, this three-ETF portfolio is likely to lag. A lot of folks have had concerns about the current multi-year bull market in mega-cap tech and their high valuations for a while. So far, it’s kept pushing higher. There’s a trade-off in pivoting more defensively. You might not be right.
But 75% of the money would still be invested in stocks. That’s the benefit of going this route instead of pushing entirely into cash. You still own heavy equity exposure and maintain the ability to participate in any further stock market gains.
The best plan is to have a plan. Establish trigger points where you’d be comfortable shifting defensively and, more importantly, moving back into your original allocation. You never want to sacrifice the long term for an uncertain short term.
