A shaky market can be the investor’s worst nightmare.
While professionals have the flexibility to monitor and adjust their investments day-to-day, the average investor keeps a much more hands-off attitude toward her portfolio. That’s smart since tinkering with your investments is generally a good way to lose money.
In a turbulent market, though, that conventional wisdom leaves you exposed. Without intervention, an unprepared portfolio can suffer. So try to be prepared. Although no strategy is completely safe, here are five ways to safeguard against volatility.
Futures and Options
Although challenging for the novice investor, derivatives can offer stability by doing well during market downturns.
Traders in the futures and options market commonly exercise short sales, investing against the performance of commodities and financial products. Combined with the VIX, the volatility index, this allows investments that specifically profit from losses elsewhere.
The upshot will be a section of your portfolio designed to do well when everything else suffers.
Learn more about derivatives and how they work.
While derivatives can profit from volatility, another key element of a stable portfolio is countercyclical investing. In other words, have assets that will tend to succeed when others do poorly.
This is also known as negative asset correlation.
A common example is utility companies, which tend to have stable growth even if the rest of the market is tumbling, or oil. As prices rise the added costs drag the entire economy. As a result, this section of your portfolio can do its best when the rest of your investments struggle.
Considered a key element to portfolio diversification: Always keep an eye on asset correlation.
Principal Protected Funds
Several investment vehicles, such as principal protected funds and Treasury bonds, guarantee the return of your principal.
Both are excellent ways to set a floor for losses, eliminating all volatility below a certain point. They also have some of the lowest rates of return for any investment outside of a savings account. As a result, neither of these should be the primary vehicle for an investor looking to grow his money. Yet as a loss-prevention mechanism these can add excellent diversification.
Mutual Funds, Not Stocks
One of the biggest sources of volatility in a portfolio, individual stocks should generally be avoided absent good cause.*
Instead, seek mutual funds. These packages offer assets grouped, often by market category. The best are assembled with an eye towards several of the principles laid out here, incorporating diverse, countercyclical assets in order to smooth out performance.
While systematic risk can haunt any portfolio, investing in stocks introduces unsystematic risk, the chance of a single company’s failure. Eliminating that is a key step towards reducing the exposure of your portfolio.
* One exception is stocks known for dividend payouts, which lend the possibility of regular profits.
Identified Risk Capital
Your portfolio will be most exposed to volatility while trying to make a profit. Indeed, many strategies outlined here have the central theme that they tend to make less money in a strong market.
So a key step in protecting your portfolio is to figure out how much money you can stand to lose. Identify this risk capital and put it to work in growth-focused sectors, then take the rest of your money to higher ground by investing it in safe assets such as mutual funds, uncorrelated assets, and even some protected vehicles.
It will help strike the balance between the frustration of slow growth and the panic of a sudden downturn.
Want to know more about investing do’s and don’ts? Try here!