Best ETFs for a Volatile Market

published 19 August 2019

Ryan Ermey: Just because the market is getting jumpy doesn't mean you have to. As major indexes decline, Kiplinger.com senior investing editor Kyle Woodley rejoins the show to talk investing strategies and ETF picks for volatile markets in our main segment. On today's show, Sandy and I tell you why a Roth IRA is the best place to stash your money from a summer job, and a new edition of deal or no deal focuses on travel planning and housing sweepstakes. That's all ahead on this episode of Your Money's Worth, stick around.

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Sandy Block: Okay, so that's a good starting point. So say your child made $2,000. If you put even some of that in a Roth IRA, the money grows tax free for decades until ... and it could be a substantial amount of money. Now, here's the part that I think is kind of clever -- say, your child really, really doesn't want to put this money in a Roth IRA. You could do it yourself. You could put the equivalent of the child's earned income in a Roth. The IRS doesn't care where the money comes from, as long as it doesn't exceed the contributors earned income for the year. So if your child earned $2,000 as a lifeguard, you could put $1,000, or you could offer to match. Tell your child, put in $500, I'll put in $500.

Sandy Block: So if they had earned income of $2,000, you could put in a thousand and they could put in a thousand, that would be the limit. But that's ... basically, that's a great way to get your child started. And the other cool thing about Roth IRAs and why we're so hard on them is they offer a lot of flexibility. Now, ideally you want your child to leave that money alone until they're 65, right? But if down the road the child has an emergency, needs new brake pads, or ends up in jail, or something like that, he needs bail money. You never know.

Sandy Block: You can always take out the amount that you contributed tax free and penalty free. So say you put in $2,000 this year, your child could always take out up to $2,000 without paying any taxes or penalties on the contribution. So it sort of doubles as an emergency fund in addition to a retirement savings plan. We'll put it in the show notes. There are several brokerage firms that are happy to help you set up custodial accounts for a very low or no minimums, and low fees, and we'll list them in the show notes. But I think this is definitely something to think about. It's a great way to sort of get your child on the path to financial security. It's a great way to teach them, because they can invest this money and then watch how they investments do and it is ... it'll last a lot longer than anything else they want to spend their summer money on.

Kyle Woodley: So the longest-standing driver has been the on again off again, threat of tariffs since early 2018. Basically it's an effort for us to try to bring more U.S.-friendly trade conditions out of our trade partners, not just China, but there's also been spats with Mexico and the European union. For the better part of two years now, we've been subjected to narratives that change almost weekly about how close or far apart Washington and Beijing are on trade talks, and the market chases those stories because of the potential economic impact. So tariffs can be used for leverage, but they're problematic, because they weigh on consumers and the companies alike. In turn, that tends to drag down the overall economy. That's especially worrisome when you're talking about two major trade partners who also happen to be the world's two biggest economies. Couple that with signs of economic weakness and other areas around the world, like Europe and Southeast Asia, and you have another reason for worry.

Kyle Woodley: Then you've got the Federal Reserve and interest rates. So the Fed can lower interest rates, which makes it cheaper for consumers and companies to borrow money, and that can spark growth. But it's also in the Fed's interest to reserve that power for when it's really needed. We're in the longest period of economic expansion and in the longest bull market in America's history. So how immediate is the need to spark more economic growth, especially if you clip your ability to do so in the midst of an actual recession? It's a difficult balancing act and it's one that Wall Street keeps finding itself guessing about.

Kyle Woodley: And there's one last thing about interest rates that actually sparked today. So recently you've heard about the yield curve inverting. In short, that's when short term rates are higher than longterm rates. This indicates that investor's longterm outlook isn't good. So one particular set of rates, which is the two year treasury bond, and then the 10-year, it recently inverted, this inversion proceeded each American recession of the past half century, and only once in that time did the two and ten curve invert without a recession following.

Kyle Woodley: Sure. So there are two bad habits specifically. So number one is panic selling. Selling in and of itself, it's not bad. If you put your more of your portfolio into cash or even other defensive positions, those are reasonable strategies, if you're worried about volatility or a broader market downturn, especially if you're closer to retirement, and you're particularly concerned about wealth preservation. But where do you get the money to go to cash? Like, unless you're stuffing gobs of money into your account when the market is declining, you probably need to sell something, But what you shouldn't do is panic sell. That's where you just start dropping positions because you've opened up your brokerage account and you just see a big sea of big red numbers.

Kyle Woodley: So instead, what you should actually do is when you're considering what you should sell, you actually want to look at it like you're buying it for the very first time. So do you like the company? Do you like it's business thesis? Is it trading at a fair price? Are you getting a good yield on it? And that's the one thing you have to consider from your present portfolio, because it's the yield on the cost you bought it, not at the current price. But what kind of time horizon do you have? So in other words, do you have time to wait out a recovery if you're wrong? If you'd still make that investment today, knowing what you know, then you should probably hold onto what you have.

Kyle Woodley: So another thing to avoid is buying garbage, buying dips is ... no, buying dips is a good idea. It's a tried and true investment thesis. This more so applies to people that have at least a few years to go to wait out a bad case scenario, but if the market does keep dropping, you'll eventually be presented with some attractive prices on companies that can eventually bounce back. That doesn't mean they won't drop even more in the shorter term, but you'll never ... you're not going to perfectly time the market. But if you can find high quality companies that are trading for reasonable evaluations and a better yield, thanks to a market dip, then consider buying. Just don't buy garbage, really dig into what it is you're buying. If the country enters a recession, you probably don't want to go into a formerly high flyer that's short on cash, and high on debt, no matter how cheap it seems.

Kyle Woodley: Sure. So just a brief note on what sector funds are. It's the most basic way to break apart the S&P 500. So, you have financial stocks, that's a sector. You have technology stocks, that's a sector. So what you want are a couple of tried and true defensive plays. So let's start with the SPDR Select Sector Utilities Fund (XLU). Utility companies are boring as all let out. You never talk about them during a bull market, but they do get popular once people start panicking, and it makes sense. So they deliver a service, so whether that's supplying energy, gas, water that you need to get by, no matter what the economy is doing. They're highly regulated. They operate almost like monopolies. So they have about as predictable a revenue base as you could want, and they typically get away with small rate hikes over time.

Kyle Woodley: Now that doesn't fuel a lot of growth, but it does let them afford typically large and growing dividends. So that'll provide some lift even if the stock itself isn't shooting higher. Of course, if you happen to be in utilities in the early stages of a bear move, then you may enjoy price upside too, because everybody else is going to start piling in for safety. So XLU is just an exchange traded fund that reduces your risk even further by spreading your investment across a couple of dozen utilities in the S&P 500.

Kyle Woodley: And then, there's also the SPDR Select Sector Consumer Staples Fund (XLP), and this has sort of a similar thrust. So the ETF invests in consumer staples stocks, which they're products that you and I need on a daily basis. So if the economy tanks, you're not going to go out and buy a third pair of Nike's. You're probably going to postpone the trip to Disney World. You're going to eat food.

Kyle Woodley: Yup, you're going to brush your teeth and you're going to go to the bathroom. And so, that baseline need is what gives them reliable revenues and profits, which again, they often return to investors in the form of dividends. So XLP holds companies like Procter & Gamble that actually make the products, companies like Walmart that sell the products, and then there's a few sneaky holdings in there too. So, it also carries alcohol and tobacco stocks, which you think about them and you're like, well they're wants, but people treat them like needs.

Kyle Woodley: So the goal is typically the same across all of them. They're trying to provide some nebulous lower level of volatility risk. A crude way to put this is, stocks that don't move as much as the broader index. How they do it can vary a lot from fund to fund. Some just take a big group of stocks, and they weight them based on their previous volatility, so the lower the better. Others try to reduce volatility by considering different predictive factors, like profits and growth, and then they build a diversified portfolio across a bunch of sectors to basically further reduce risks.

Kyle Woodley: So one recommendation is iShares Edge MSCI Min Vol USA ETF (USMV). I'm very sorry everybody. So this is actually a pretty complicated fund, but to break it down, it takes 600 large in mid cap stocks. It identifies the ones that have lower volatility. It then weights them based on a multi-factor risk model, and then it's tweaked in a few more ways. So like, making sure that the sectors are represented within about 5% of that original index in stocks.

Kyle Woodley: Exactly. So, a little bit difficult to understand. Something that's a little bit easier, and that'll appeal to income hunters is Legg Mason Low Volatility High Dividend ETF (LVHD). Again, so this has a couple other roles, but it's generally just looking for high and high quality dividend yielders, that also have low price and earnings volatility. And it yields a pretty nice 3.5% right now, which can act as a buffer against capital losses.

Sandy Block: Well and you can still deduct mortgage interest when you buy a house. What has changed is under the tax overhaul, the standard deduction was doubled, and that means that a lot of people who used to deduct interest on their mortgages aren't doing it anymore, because it makes more sense for them to claim the standard deduction. So when people say, "Well, I want to buy a house because I know I'm going to get this big tax break," that's no longer a given, and that shouldn't be what drives your decision. You shouldn't buy a house because you think you're going to save on taxes.

Sandy Block: No, my deal is from our September cover story, Simplify Your Finances, and one of the stories written by our travel guru Miriam Cross called Take The Stress Out of Travel Planning, has a very fun website called a rome2rio.com, and we'll put this in the show notes. But basically what this does, and I've had a lot of fun playing around with this. I mean, you can go anywhere on the internet and find flights and flight rates. There's a million places you can do that. This, when you put in where you are and where you want to go, it will show you multiple options, flights, bus train and driving.

Sandy Block: So even though I would go somewhere else once ... if you decide for sure you want to fly, I would go somewhere else to find, but if you just want to sort of give think about the time, and the cost of these various options, this is a really fun way to play around with your choices. I mean, you're not ... you went to San Diego recently. I mean, according to this website, it would take you 42 hours to drive there. So I think in that case, flying is the only choice. But say you're in DC, and maybe you want to go to Philly. You could drive, you could take the train, you could take the bus, or you could fly. And this kind of gives you an idea of not just the cost, but the time that it would take.

Ryan Ermey: I had ... I mean, I don't know if you've ever done ... I've done like these sort of planes, trains and automobiles trips before. I went ... I mean, you end up traveling for like 24 hours straight, but it can be a lot cheaper. I did ... I was in Rome ... I flew out of Rome, Fiumicino. I was going to this like rural town in Hungary, where a friend of mine was living, where he's from, I should say. And I flew from Rome to Vienna, and then caught a train across Vienna to a different train station, and then a train from there to Budapest, and a train ... a bus across Budapest to a different train station, and then a train from that other train station all the way out to where my friend lived. And so ... and I had to do that in the analog days. I mean, the interesting thing is if you're going around to Austria or whatever, people speak English, or at least German is pretty intelligible in terms of where you're going. The Magyar that you see in Hungary, it might as well be hieroglyph. So, I was pulling out maps and circling things.

Sandy Block: And hopefully it would tell you how to get there in all these various ways. So I just think it's kind of fun. And the thing that it does take into account too is your time. You know, if you're trying to decide between driving or taking the bus, or the train, how much time are you giving up to take another option? So I would just ... we'll put that in the show notes, but I just think it's an interesting ... as people explore different ways to get around, it's not just cost, it's also time and effort, and this kind of lays it out pretty well.

Ryan Ermey: Oh, can't wait to play with it. That'll wrap it up for this episode of Your Money's Worth for show notes and more great Kiplinger content on the topics we discussed on today's show, visit Kiplinger.com/links/podcasts. You can stay connected with us on Twitter, Facebook or by emailing us at podcast@kiplinger.com. And if you like the show, please remember to rate, review and subscribe to Your Money's Worth wherever you get your podcasts. Thanks for listening.

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Block joined Kiplinger in June 2012 from USA Today, where she was a reporter and personal finance columnist for more than 15 years. Prior to that, she worked for the Akron Beacon-Journal and Dow Jones Newswires. In 1993, she was a Knight-Bagehot fellow in economics and business journalism at the Columbia University Graduate School of Journalism. She has a BA in communications from Bethany College in Bethany, W.Va.