Why Do You Need to Have a Portfolio Protection Strategy?
Much like the market, your portfolio protection strategy should be dynamic in nature. With changing laws, market situations, economic expansion and downturn, the value of your assets and their tax liabilities also change. Creating a portfolio is not a one-time task. There will be many times when you will be required to make immediate decisions to maximize your profits or save yourself from huge losses. This is why having a portfolio protection strategy is crucial. A strategy protects your portfolio against market volatility and helps you achieve financial freedom. Here’s how.
Why do you need a portfolio protection strategy?
Let us take the example of the economic slump of 2007-2009 – one of the biggest crises to hit the world in recent times. The international markets saw a big decline and many people lost their jobs due to recession. People on the verge of retirement decided to postpone it, some people hastily withdrew their money from the market, while some continued to invest. The outcomes were different for all these people, but the common fear of losing money lingered in everyone’s mind.
Having a portfolio protection strategy gives you an edge over volatile markets and provides a safety net for your investments. A protection strategy can save you in times of a severe financial crisis.
What strategies can you adopt to guard yourself against a volatile market?
Every portfolio is different, and so are every person’s financial goals. But a common objective for most investors is to preserve their principal amount and let their money grow. Here are some strategies that can be applied to most portfolios:
1. Diversification
One of the most common go-to strategies for an investor is to diversify. Although nothing can be guaranteed in a market, diversified portfolios are known to reduce the risk substantially. Diversification runs on the idea that different assets and stocks, will not react to market volatility in the same manner. So, the chances of them all running into loses at the same time are considerably less.
2. Co-relating assets
When we talk about diversification, we must also address correlation. Assets can co-relate to one another in two manners:
- Positively: This happens when two assets behave in the same way. So, if one asset shows an appreciation of 5%, the other also appreciates by 5%. The relationship between the two is known as a correlation coefficient.
- Negatively: When assets fare in opposing manners, they are said to be negatively co-related. For example, if asset A depreciates by 15%, asset B would go up by 15%.
The correlation coefficient depends on the type of stock you invest in, and can differ for each asset. You need to have a balanced asset correlation in your portfolio to reduce risk.
3. Buying a put option
This option gives the investor the right to sell a certain stock within a certain amount of time. The price of the stock is always pre-decided. So, if the cost of the asset falls beyond the pre-decided price, you can still sell it back at a profit. Put options are an effective way to beat a bearish market. But be mindful of the premium that you pay. Typically, the premium on put options increases when the market is more volatile.
4. Stop Orders
Also known as a stop loss, these orders automatically buy or sell stocks when their price reaches a certain amount. Stop losses are assigned to a broker. So, if you buy a stock for $100, you can order a broker to sell it if its value goes up to $150. Likewise, you can also order them to sell it if the price drops to $80, so you don’t incur too many losses. People usually fix a percentage for both profit and loss. The broker monitors the progress of the stock and acts accordingly. Stop losses are automated and easy to manage. They also eliminate the risk to a great extent.
5. Structured Products
These have not yet gained widespread popularity but are a great tool to protect your portfolio. Structured products are tied to an index and offer minimal downside losses. But they can lack liquidity. They are also best used as long-term investments as they bring in full returns only on maturity. They do not perform well as a short-term investment.
6. Dividend-paying stocks
When you invest in a business, the company pays you dividends. These are nothing but a part of the company’s profits. Investing in stable and secure companies can be a great way to increase your earnings even in a market downturn.
To sum it up
There is no way to predict what lies in the future, so it is better to follow a self-preservation strategy for your portfolio. Implementing tactical plans, along with proper diversification, can keep you guarded against the uncertainties of the market. If we take the current scenario into the picture, we can see how many experts are predicting a recession in 2020, particularly for the housing market. Try to keep yourself well-informed about what’s happening in the financial world, so you can adopt strategies well in time and avoid future downturns.
Do you think your portfolio is secure from probable risks? Approach financial advisors to find out which portfolio protection strategy is the most appropriate for you.
