Certain investments, such as stocks, are almost always volatile. But you may feel as though you need a particularly strong stomach these days. Stocks still provide the best long-term returns over other major asset classes (such as bonds and cash) and are generally appropriate for retirement accounts that won’t be needed in the next decade or more. But if you’re closer to retirement or simply require greater peace of mind, here are several defensive investing strategies you might want to consider.
Spread Risk Around
Even those who are bullish on the market and relatively risk-tolerant should consider diversifying their portfolios across different asset classes, industries, and geographies. But if you’re risk-averse, this strategy is essential.
Whether you mainly invest directly in securities or access the market via mutual or exchange-traded funds, decide how you want to allocate percentages in stocks, bonds, and cash (money-market accounts). You may also want some international exposure and to invest in such areas as real estate and commodities.
If you buy funds, pay attention to their sector allocations and the number and weighting of individual holdings. For the most part, more diversified funds will carry lower short-term risk. This is because different types of securities tend to move in different directions. So if some types of investments are falling in value, others may be rising at the same time, resulting in steadier overall performance.
Buy on the Cheap
Value investing, or buying “cheap” stocks, is a classic strategy made famous by such investing icons as Warren Buffett and Benjamin Graham. Value investors look for companies priced low relative to their business fundamentals and such investment ratios as price-to-earnings. Usually, these stocks have reacted negatively to some form of bad news, such as poor quarterly earnings, or are depressed because the general market has declined and punished stocks across the board.
Because they’re relatively inexpensive, value stocks typically have less distance to fall when the larger market declines. But most value strategists are in it for the long term. There’s a common misconception that buying bargain-priced stocks leads to immediate returns. In fact, it can take years before a value stock becomes what its investors consider fully valued.
Roll with Economic Cycles
Even experts have trouble predicting recessions. But certain indicators frequently coincide with economic downturns. For example, many professionals suggest caution when bond markets exhibit a moderate or flat yield curve and widening credit spreads. Another red flag can be a Purchasing Managers Index reading below 50, indicating that the manufacturing sector is contracting.
If the economic cycle seems to be shifting into lower-growth territory, some investors favor consumer staples (think toothpaste and soap companies), utilities, and health care stocks. These sectors may offer goods and services that people buy regardless of the economic climate. Also, because gold is perceived as having an “intrinsic” value, it’s usually considered the ultimate defensive investment.
In the same scenario, cyclical investors may ease up on consumer discretionary (such as travel and luxury goods) stocks, technology, and biotech (which tend to be heavily leveraged) and companies in the financial services and energy industries. Much depends on specific indicators, such as inflation and interest rates.
Best for Most
Although reallocating investment portfolio holdings can possibly help you reduce short-term volatility, attempting to “time” the market is rarely successful. For most investors (and especially those with less investing expertise) the best strategy is to build a diversified portfolio that reflects your financial goals, time horizon, risk tolerance, and other personal factors, and then leave it alone.
You’ll want to rebalance portfolio allocations when there are major market changes. For example, if bonds do particularly well one year, a bond fund may grow disproportionately to other holdings and it probably makes sense to rebalance your portfolio. Contact us for help building a diversified portfolio and to discuss such issues as volatility and rebalancing.
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This article appeared in our Q2 newsletter. Click below to view the full edition.