Investing is a risky business. No one can anticipate sudden market downturns. In hindsight, we’ll read all kinds of explanations for why the most recent one happened and after a few analysts will pinpoint the factors that caused it. But are there any investments that are consistently protective? In theory, we should be able to protect our investments by choosing negatively correlated assets: things that move in opposite ways. In the stock market, for example, when stocks go up, we’ve expected bonds to go down. And there are categories that are supposed to have a weak correlation—meaning that they may move in the same general direction, but not with the same force. Below I will try to determine if Investing In Defensive Assets is right for your investment strategy.
How to Understand a Defensive Investment Strategy
For decades, U.S. stocks and international stocks have been thought to have low correlations. In fact, there were investment types that seemed unrelated to the stock or bond market—such as commodities or real estate—and investors believed it was possible to create a portfolio that would protect their wealth in any situation. We live in a connected world, where stock markets are linked across countries and regions. It’s not always obvious what type of movement will affect other investments. To consider a few examples, it turns out that problems in emerging markets can affect basic materials and commodities.
There are many questions regarding how best to recover from a downturn. Will one country rebound faster than another because it is larger? Will another nation with better social safety nets return people to work faster and attract more investment? Is real estate linked to consumer spending (stores and malls), travel (hotels), office space (working from home), rental demand (price of mortgages, housing and unemployment) or all? Will each of these markets recover or will they be fundamentally changed? It’s hard to say, except in hindsight.
A defensive investment strategy involves regularly re-balancing a portfolio to maintain an intended asset allocation and buying high-quality, short-maturity bonds and blue-chip stocks. Defensive strategies also involve diversifying across sectors and countries; placing stop loss orders; and holding cash and cash equivalents in down markets. Such strategies are meant to protect investors against significant losses from major market downturns.
You can use a number of investment strategies to manage your portfolio. Offensive investment strategies may involve options trading and margin trading, both of which could have higher fees and tax liabilities than a passively managed portfolio. A balanced investment strategy combines elements of both the defensive and offensive strategies.
What are some types of Defensive Investments?
Selecting investments in high-quality short-maturity bonds, such as Treasury notes and blue-chip stocks are solid tactics for a defensive investment strategy. Even when picking stocks, a defensive portfolio manager will stick to large, established names with good track records. Today, that portfolio manager is more likely to lean towards exchange traded funds (ETF) that mimic market indices, as these offer exposure to all the established stocks in one diversified investment.
Defensive stocks are companies that provide consistent dividends and stable earnings regardless of the state of the overall stock market. Because there is a constant demand for their products, defensive stocks tend to be more stable during downturns in business. Defensive stocks also have a lower chance of going bankrupt because they are less volatile than other stocks. However, these stocks often perform poorly during bull markets and may lead their holders to misjudge or mistime their investments.
Should you invest in defensive assets for retirement?
In order to consider a defensive strategy, you need to take into account your timeline and how far away is the goal. If you’re in retirement, withdrawing from your portfolio, you need assets that will maintain solid value so that you’re not forced to sell those with a loss. The 2007-2009 Recession tells us anything—it can take up to four or five years for values to recover fully. In the event that you need to access your retirement accounts immediately, you may need to employ a defensive strategy that can protect against losses over a long period of time. However, it is possible that your investments will experience value fluctuations from day to day. If you have more than five years before necessary withdrawals, you may want to adopt a long-term strategy and avoid stressing over short-term losses.
When the market is falling, don’t get spooked. Look at both the dollar amount and the percentage drop. Some people feel more anxious about a certain measure than another, so it’s important to know what works for you. Defending yourself against market volatility means protecting yourself against your own impulses and short-term emotions so that you can make good decisions for the long run.
