Even in the best conditions, the stock market has its ups and downs. Yet, when market conditions take a turn for the worst, a few weeks of losses can make it seem like the sky is falling. As losses mount, it’s easy to abandon your strategies and give into emotion… which tends to lead to rash decisions. Instead of selling and locking in losses, investors need to explore portfolio protection strategies and bide their time until markets recover.
Wondering how to safeguard yourself from mounting losses? Here’s a look at five portfolio protection strategies that can minimize and even offset losses uncured during periods of market volatility or downtrend.
Best Portfolio Protection Strategies
1. Diversification and Reallocation
While a broad-market downturn will create losses across the board, it’s important to remember that not every industry sees the same level of loss. For instance, defensive investments like consumer staples aren’t typically affected as much by economic headwinds. Conversely, debt-strapped growth stocks tend to suffer mightily. Look at where your portfolio allocations stand and explore opportunities for diversification through reallocation. It’s the concept behind Modern Portfolio Theory.
Lock in capital losses on stocks you no longer have a bullish long-term outlook on. Open positions with well-run companies in sectors you have little-to-no exposure in. Cut and add to positions to balance your portfolio’s weight. In times of turbulence, making small, calculated adjustments in favor of balance is often much better than making broad, sweeping changes rooted in emotion.
2. Using Put Options to Offset Risk
Put options are a speculative bet that the price of an asset will decrease within a certain time frame. If you’re a bullish long-term investor, you can use put options to play devil’s advocate when it comes to your portfolio. Buying a put option allows you to trim or exit your position at a desirable price if the share price plummets. And, if it doesn’t, your put option simply expires out of the money, worthless. You only stand to lose the premium paid for the option.
Put options are an easy concept for almost any investor to understand. If you’re not currently using put options as a hedge against volatility, it’s worth exploring them. Keep in mind that you’ll need to have a brokerage account with options trading enabled, which usually means applying for this ability.
3. Using Trailing Stops as Safeguards
Stop-loss orders are a great way to safeguard against falling share prices. And while most investors are familiar with hard stops, which trigger the sale of stock at a specific price, a far more useful tool is the trailing stop.
Trailing stops are good-till-canceled, and continue to match the price of a stock as it grows. Say that you set a trailing stop at 10% of a stock’s price. If that stock trades for $100, the order will trigger a sale if the price dips to $90. However, if the stock climbs to $105, the new trigger will become $94.50. The sell price of the trailing stop will continue to rise as the price does, but doesn’t move if the share price depreciates. In this way, it locks in profit to a certain degree, while always protecting against a known degree of loss.
4. Forming a Dividend-Heavy Portfolio
When share prices become depressed or flounder, dividends become more appealing for several reasons. For starters, companies able to offer dividends tend to be those with stable, profitable business models that can afford to return value to shareholders. Second, investors can look toward scheduled dividend disbursements as income. Finally, dividend reinvestment makes it possible to continue investing in companies with healthy operations.
For those investors sick of volatility or who need to take a more defensive approach to portfolio management, dividends are a safe bet. This is especially true when it comes to the Dividend Aristocrats: companies with 25 years or more of dividend growth. In many situations, dividends offer a better source of passive income than most bonds. Just be aware that dividends are only guaranteed so long as the company has the free cash flow to pay them.
5. Adding Safe Haven Investments
Safe haven investments are those that tend to perform better when the market is in turmoil. The most obvious safe haven investments are precious metals like gold, silver and platinum. REITs are also great safe haven investments, provided the real estate market remains strong where the stock market falters. Identifying safe haven investments that supersede market headwinds is a great way to bring stability and balance to an at-risk or suffering portfolio.
It’s also smart to look into stable fiat currency in 2022. With the crypto markets depressed, the liquidity of the Forex market is attractive to investors comfortable in trading stable currency pairs. Inflation has brought additional activity into Forex, which bodes well for investors seeking to capitalize.
Portfolio Protection Needs to be Proactive, Not Reactive
If you find yourself rushing to make moves to safeguard your portfolio against market turbulence and downtrend, take a moment to stop and consider the situation before you act. Instead of locking in losses or making split-second decisions, consider adopting a portfolio protection strategy.
Reallocating and diversifying can spread risk around and limit losses. Put options and trailing stops help preserve your current allocation while mitigating risk. Spreading wealth into dividends and safe haven investments can anchor the rest of your portfolio. These strategies, whether executed individually or together, are a smarter way to cope with volatility and avoid locking in losses prematurely.