Make your portfolio more defensive
Football teams aren’t the only ones relying on defense to protect a lead. Investors can also increase their chances of success by listening to the voice in their head sing Dee-fense!
Going all-in all the time isn’t always the best investment game plan, especially after a big rally such as the current bull market, which has propelled the S&P 500 Index to a gain of over 100%. “People have to remember that markets don’t always go up,” says Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.
This is especially true now. With warnings of headwinds for the economy ranging from the Federal Reserve’s slowing stimulus to slowing corporate profit growth in 2022 to crises in China, it’s unclear when the flashing green light on Wall Street. will turn yellow or red.
If your gut tells you that a big drop in the stock market is coming, or you’re guilty of letting your winners run for too long, or the big days keep you from sleeping at night, maybe it’s time to cut back. the risk in your portfolio.
Adjusting a portfolio to make it more defensive doesn’t mean quitting the stock market entirely or putting all your money in a bank account that doesn’t earn any interest. We’re talking about a tactical approach that reduces your portfolio risk and volatility, protects gains, and keeps your asset mix in line with your risk tolerance.
“Sell to your sleep point,” says Barry Bannister, chief equity strategist at investment bank Stifel. Here are ways to bring a high-flying portfolio closer to the earth.
Tilt your portfolio towards more defensive sectors
Buying highfliers makes sense when the market is in go-go mode. But more defensive corners of the market tend to resist downdrafts better – think utilities, real estate investment trusts (REITs), companies that sell basic consumer goods like toilet paper and toothpaste, and healthcare companies that manufacture prescription drugs and medical devices.
As market turmoil increases, investors look to stable, financially sound, dividend paying companies whose fortunes do not change and decline with the economy. “People have to buy shampoo and ketchup regardless of the unemployment rate,” Shalett explains.
During bear markets since 1946, the healthcare sector recorded the lowest average loss (-12%), followed by consumer staples (-13%) and real estate (-18%), according to CFRA , a Wall Street research firm. The most aggressive and economically sensitive sectors fell by around 30% on average. Of course, playing defense all the time will result in lower returns in the long run.
But for those looking to reduce risk, one way is to reduce holdings in aggressive sectors, such as tech, and move the money into low-cost exchange-traded funds that track defensive sectors, Bannister says. .
Take into account Utilities Select Sector SPDR Fund (XLU), which has a 3% dividend yield and includes principal stake NextEra Energy (NEE), the utility giant and renewable energy; the SPDR Fund for Selected Sector for Health Care (XLV), which owns COVID-19 vaccine maker Johnson & Johnson (JNJ), insurer UnitedHealth Group (UNH) and medical device maker Medtronic (MDT); the SPDR Fund for the Consumer Staples Sector (XLP), whose major holdings include consumer products giant Procter & Gamble (PG) and snack and non-alcoholic beverage vendor PepsiCo (PEP); and the SPDR Sector Select Real Estate Fund (XLRE), with stakes in American Tower (AMT), a cell phone tower REIT, and Prologis (PLD), a logistics-focused real estate company and one of the Kiplinger ESG 20, our list of ESG investments favorite.
Reduce portfolio risk by reducing big winners
Congratulations if you own COVID-19 vaccine maker Moderna (MRNA) – the top performing stock on the S&P 500 in 2021, up nearly 200% – generator maker Generac (GNRC) – up 80% – or technology experts such as Google Parent Alphabet (GOOGL), up 60%. But don’t fall in love with these stars. Many investors make the mistake of hanging on to winners for too long.
There is a double risk in not taking at least a portion of your profits.
First, your overall asset mix may end up being too equity-heavy, thanks to the disproportionate impact of your big winners. Second, you risk owning a stock that has become overpriced and is more vulnerable to a sell-off.
Taking profit on the table reduces your portfolio risk. Proceeds can be temporarily held in cash to give you purchasing power if stocks go up for sale, or you can reinvest in more stable stocks (such as dividends) or less volatile bonds.
Focus on low volatility stocks
You can also smooth out your portfolio run by switching to stocks that show less volatility than the S&P 500 as a whole, says Todd Rosenbluth, head of ETF and mutual fund research at CFRA.
While you won’t get the full benefits of the market in strong markets, holding a wide range of low-volatility stocks will limit your downside when the market weakens.
Rosenbluth likes it Invesco S&P 500 Low Volatility ETF (SPLV), which owns the 100 least volatile stocks in the S&P 500 and weights the fund not by market value but by volatility. The lower the volatility of the stock, the higher the weighting of the fund, which means it has large portions of holdings in defensive sectors such as utilities, consumer staples and real estate, but reduced portions of equities in technology and other higher volatility sectors.
Discover high quality companies
High quality stocks – those with strong balance sheets, stable earnings, low debt, lots of free cash flow (money left over after paying operating expenses and expenses to maintain or grow the business) and Strong franchises known to increase sales and profits in good times and bad – are generally defensive actions.
Features like these “provide a margin of safety and allow companies to survive the ups and downs of the economic cycle,” said Kristina Hooper, chief global markets strategist at Invesco, a fund company.
Take into account IShares MSCI USA Quality Factor (QUAL), an ETF that holds a collection of stocks with strong balance sheets and stable earnings. The fund’s top five holdings are Facebook (FB), Nike (NKE), Microsoft (MSFT), Apple (AAPL) and Nvidia (NVDA).
Double the bet on dividend paying stocks
Add dividend payers to your watch list.
“Dividends serve as a cushion” and offer downside protection, Rosenbluth explains. A good choice is the Vanguard High Dividend Yield Index ETF (VYM), which returns 2.7%, or double the return of the S&P 500.
Dive into short-term bonds
Fleeing to bond safety is not so foolproof these days, as bonds are trading at record prices and record yields. And now the Fed is talking about cutting its stimulus and raising rates as the economy recovers and inflationary pressures intensify.
To avoid losing principal due to rising rates (which usually leads to lower bond prices), stick to shorter-dated bonds.
Bonds with maturities between one and five years are less sensitive to interest rate fluctuations than bonds with longer maturities. “Your exposure to interest rate risk is more modest,” says Shalett of Morgan Stanley. A good option is the JPMorgan Ultra-Short Income ETF (JPST).