5 Common portfolio protection strategies

portfolio protection strategies

The primary aim of saving money and investing it long-term is to preserve capital and make it grow- losing money is simply not an option. However, the stock market is highly volatile and has no fixed guarantees. Any crisis or even news reports can drive the prices of stocks up or down.

But how do you protect your investment portfolio from such volatility? More importantly, how do you ensure that the value of securities in your investment portfolio does not diminish in volatile times?

In this blog, we will explore the top 5 commonly used portfolio protecting strategies and how can you use them to protect your assets from the impact of market risk-led volatility.

What is a portfolio protection strategy?

Portfolio protection strategies are time-tested strategies that investors have used to protect their investment portfolios from market risk and extreme volatility. These are proven strategies that are used to limit a portfolio’s losses and ensure that a portfolio’s value does not tumble. Portfolio managers, too, use these tactics as a hedging strategy. These strategies can also be used to minimize losses in a portfolio when the stock prices decline, but you don’t want to sell the stocks in a bid to retain them for the long term.

Why do you need to have portfolio protection strategies in place?

Buying and holding for the long-term is an excellent tenet of value investing. However, simply buying and forgetting about the securities in your portfolio can do more harm than good. The idea here is not to develop a trader’s mentality where you buy and sell securities daily but to have safeguards. These safeguards protect the value of your assets from decreasing in adverse situations like financial crises, wars, and economic downturns. Although these events may be sporadic and temporary, they can adversely hamper your investments if you have not put checks and balances.

For example, the onset of the COVID-19 pandemic in March 2020 was marked by the Indian markets hitting the lower circuit in reaction to global uncertainty. However, those couple of days witnessed this phenomenon- people were withdrawing their money from markets globally. Of course, 2020 is behind us, and the markets are now at all-time highs.

Having portfolio protection strategies in place made the outcome of this phenomenon different for all investors. Those who had used portfolio protection strategies fell on a safety net, while those with no such measures suffered immense losses.

This is why it becomes critical to have portfolio protection strategies to prevent an untoward economic crisis from eating into your investments. TejiMandi is a Sebi-Registered Research Analyst with expert portfolio protection strategies up its sleeve. Some of these include:

Top 5 commonly used portfolio protection strategies

1. Portfolio diversification

One of the most common portfolio protection strategies you can use is diversification. It is a heavily used, tried-and-tested strategy that protects investors from market volatility. Portfolio diversification is known to reduce the impact of market volatility significantly. A diverse portfolio is also known to overcome market instability unscathed more than a concentrated portfolio.

With portfolio diversification, the idea is to invest in a range of different assets and securities that do not have a similar relationship with the market and market volatility. The idea is to buy a large quantity of different assets that differ at their core. This means that if one asset in your portfolio is sensitive to a bearish market, other assets in your portfolio may not have the same reaction.

For example, you can consider having a mix of equity and mutual funds, along with some sovereign gold bonds, REITS, and Government bonds, to diversify your portfolio and mitigate risk.

Moreover, if you are opting only for equity, consider investing in a range of sectors- all sectors will not react similarly to an event, report, or news. For example, during peak COVID-19 times, when hospitality, hotel, and tourism stocks hit, pharma, FMCG, healthcare, and other similar sectors saw a boom.

Read all about Portfolio Diversification and how it helps to achieve balance, especially during tumultuous times at the markets.

2. Put options

Another portfolio protection strategy you can use is buying put options.

A constituent of derivative trading, a put option, is a contract that gives the buyer of an option the right to sell or not sell an underlying asset at a specific price and time that has been agreed upon in advance. The key here is to note that the buyer has the right to make the sale or not and is not obligated to do so.

Since the underlying asset’s price is pre-decided, you have the right to sell it whenever you want- whether the price goes up or down in the future. If the cost of the underlying asset decreases beyond the pre-decided price, you will have the opportunity to sell it at a profit.

Put options allow an investor to beat a bearish market. However, it is important to keep the premiums on the options in check since the premium can increase significantly in a volatile market.

3. Stop losses

A stop-loss order is an order you place in the market to sell a stock once its price reaches a certain point. For example, if the price of RIL shares is Rs 2,400 per share and you want to sell it without making a loss of Rs 5, you can create a stop-loss order to sell this share. The stop-loss order will then be at Rs 2,395. If the stock price starts coming down, you can be assured that your stock will be sold at Rs 2,395 to ensure that you don’t incur any losses beyond Rs 5.

Stop-loss orders come in handy in volatile markets when there is high fluctuation in the stock prices. These are automated on most online brokers and are fairly easy to manage.

4. Dividend-paying stocks

One of the easiest and most convenient ways to protect your investment portfolio is by investing in dividend-paying stocks. These are the stocks that have historically paid high dividends to their shareholders. Dividends are a part of the company’s total return. Some companies are known to pass on the bulk of their profits to their shareholders as a goodwill gesture.

This can help you make significant gains quarterly and the stock returns. Essentially, this increases the overall return clocked by your portfolio. Therefore, even if the price of a stock goes down for a while, the high dividends basked in can offset the decline.

High dividend-paying stocks can help lower the volatility for risk-averse investors when the markets are generally bearish.

5. Rebalancing portfolio

Asset allocation is an integral part of having a fool-proof investment portfolio. Ideally, your funds are divided and invested in different asset classes and securities. However, this must be done in tandem with investment portfolio rebalancing strategies.

Rebalancing the portfolio is a protection strategy that involves fine-tuning the portfolio at least once a year. Based on the happenings of the entire year, you can assess your portfolio, your finances, risk profile, and investment goals and realign your portfolio accordingly. This can help identify the areas that call for trimming or increasing investment. Additionally, rebalancing your portfolio can also help you increase your returns when you sell the assets higher than they were bought for.

The takeaway

Many other portfolio protection strategies can help you stave off losses and maximize your returns. Not indulging in panic selling and separating your emotions from your investments are some other protection strategies that can be used to ensure volatile markets don’t erode your assets.

However, these portfolio protection strategies work best under the aegis of an expert investment professional who makes calculated decisions about which strategies are best suited for a particular portfolio. TejiMandi helps investors do this with unbiased, objective, and honest investment advice that is aimed at adding value to the life of an investor.

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