Defensive Investment Orders: Strategies To Protect Your Portfolio

Defensive investment strategies are designed to protect your portfolio from losses rather than increase its value. They are conservative methods of portfolio allocation and management that aim to minimise the risk of losing capital. Defensive investment strategies are suitable for risk-averse investors or those nearing retirement. They are also beneficial during market downturns and volatility, helping investors protect their capital.

A defensive investment strategy focuses on long-term gains rather than quick wins. It involves investing in stable products that have proven themselves over the years, such as stocks in established companies that pay fixed dividends each year and show little volatility. It also includes bonds and other fixed-interest-rate products that provide stable returns.

A well-diversified defensive portfolio often includes bonds, blue-chip stocks, dividend-paying stocks, and exchange-traded funds (ETFs) that mimic market indexes. Defensive investors also tend to invest in sectors such as utilities, food and groceries, healthcare, and consumer staples.

Diversify your portfolio

Diversifying your portfolio is a key part of any investment plan. The concept is based on the idea that the future is uncertain and that no one can predict what will happen. By diversifying your portfolio, you can smooth out the inevitable peaks and valleys of investing, making it more likely that you'll stick to your investment plan. Here are some strategies to help you diversify your portfolio:

• It's Not Just Stocks vs. Bonds: While stocks and bonds are the traditional way to diversify a portfolio, it's important to consider other asset classes and sectors within the economy. Over time, portfolios can become overly exposed to certain asset classes or specific sectors and industries. To maintain proper diversification, consider trimming back on areas that have become overweighted.
• Use Index Funds: Index funds are a great way to build a diversified portfolio at a low cost. Purchasing ETFs or mutual funds that track broad indexes such as the S&P 500 allows you to buy into a diverse portfolio for a low management fee. This approach is easier than building a portfolio from scratch and can help ensure you have exposure to different industries and sectors.
• Don't Forget About Cash: Cash is often overlooked in portfolio building but can provide protection during a market sell-off. Holding cash in your portfolio can help it decline less than market averages during a downturn and provides optionality, allowing you to take advantage of future investment opportunities.
• Think Global: Don't forget about international investment opportunities. There are increasingly attractive options in emerging markets and countries with faster long-term growth rates than the U.S. International diversification can also protect you from negative events that impact only the U.S.
• Periodic Rebalancing: Over time, the size of the holdings in your portfolio will change as some investments perform better than others. To maintain a diversified portfolio, it's important to rebalance your portfolio occasionally to ensure each investment is appropriately weighted. This typically involves selling parts of high-performing sections of your portfolio and adding to low-performing classes.
• Target-Date Funds: These funds allow you to pick a date in the future as your investment goal, often retirement. When you're far from the goal, the fund invests in riskier but higher-return assets like stocks, and as you get closer to your goal, it shifts to safer but lower-return assets like bonds or cash.

While diversification is important, it's possible to over-diversify your portfolio. Holding multiple funds in the same category or too many different investments can reduce the benefits of diversification. Focus on holding a few uncorrelated assets, or assets that move in opposite directions, to get the most benefit.

Use stop-loss orders

Defensive investment strategies are designed to protect your portfolio from losses rather than to increase its value. A stop-loss order is a key tool in this strategy.

A stop-loss order is an instruction to your broker to sell a stock if its price falls to a certain point. It is designed to limit an investor's loss on a security position that makes an unfavorable move. For example, setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%.

There are several advantages to using a stop-loss order. Firstly, it costs nothing to implement. You will only be charged a regular commission once the stop-loss price has been reached and the stock must be sold. Secondly, you don't need to monitor your holdings daily. This is especially useful if you are on vacation or unable to watch your stocks for an extended period. Thirdly, it helps to prevent emotional decision-making. Investors can often become attached to stocks, holding onto them for too long in the hope that they will recover. A stop-loss order can prevent this.

However, there are also some disadvantages to using a stop-loss order. A short-term price fluctuation could activate the stop and trigger an unnecessary sale. The key is picking a stop-loss percentage that allows a stock to fluctuate day-to-day, while also limiting downside risk. Setting a 5% stop-loss order on a stock that has a history of fluctuating 10% or more in a week may result in an unnecessary sale.

Overall, a stop-loss order is a useful tool for investors looking to protect their portfolio from losses. It is important to carefully consider the potential advantages and disadvantages before implementing this strategy.

Rebalance your portfolio

Defensive investment strategies are designed to protect your portfolio from losses rather than increasing its value. Here are some detailed instructions on how to rebalance your portfolio as part of a defensive investment strategy:

Understand the Basics of Rebalancing

Rebalancing a portfolio involves changing the weightings of assets to restore the original asset allocation. This is done by buying or selling assets to reach the desired portfolio composition. Over time, the values of assets change, causing the original asset mix to shift, which can alter the risk profile of your portfolio.

Know When to Rebalance

The frequency of rebalancing depends on various factors such as age, risk tolerance, and transaction costs. It is generally recommended to rebalance at least once a year, but some investors may opt for quarterly or biannual rebalancing.

Record and Compare Asset Allocations

Keep records of the total cost of each security and your portfolio as a whole. Compare the current value of each asset class and calculate their weightings by dividing the current value by the total portfolio value.

Adjust Your Portfolio

If the weightings have changed significantly, take the current total value of your portfolio and multiply it by the original percentage weightings assigned to each asset class. This will give you the amounts that should be invested in each class to restore the desired allocation.

Consider Tax Implications

When selling profitable investments, be mindful of the taxes incurred. In some cases, it may be more beneficial to avoid selling and simply contribute new funds to the underweighted asset classes while continuing to contribute to the underweighted ones.

Use a Robo-Advisor

If you feel overwhelmed, consider using a robo-advisor. These are automated services that can help with portfolio selection and rebalancing. They often start with a survey to determine your goals, timeline, and risk tolerance, and then provide a well-diversified investment portfolio that is rebalanced as needed.

Additional Tips

• Avoid checking your investment values too frequently, as this can lead to overtrading and inferior returns.
• Create a personal investment policy statement that includes your investment mix, asset allocation, and rebalancing parameters, and stick to it.
• In taxable accounts, minimise taxes by selling losing positions to offset capital gains or practising tax loss harvesting.
• Maintain a long-term focus and avoid getting distracted by short-term market movements.
• Remember that investing is a way to turn today's earnings into future financial security.

Invest in defensive stocks

Defensive stocks are shares that provide consistent dividends and stable earnings regardless of the state of the overall stock market. They are also called non-cyclical stocks because they are less prone to the economic cycle of expansions and recessions.

Defensive stocks are a good option for investors who don't know much about the stock market as they allow investors to get a feel for the market first without requiring them to burn through their capital with more aggressive stocks. They are also suitable for risk-averse investors as they lower the risk substantially while offering an appropriate reward.

• Identify defensive stocks: Look for stocks with a low beta, as they are less affected by market swings. Defensive stocks traditionally come from sectors that produce necessities or consumer staples. Examples include utilities, healthcare, and consumer staples.
• Reduce portfolio volatility: Defensive stocks can help to reduce the volatility of your portfolio. During economic recessions, defensive stocks can protect investors from further losses.
• Steady revenue stream: Defensive stocks provide a steady revenue stream through dividends, which are typically paid as a flat amount per share. This can result in a higher dividend yield as the stock price falls.
• Suitable for less experienced investors: Defensive stocks are a good option for those who are new to the stock market as they are less risky and provide a chance to get a feel for the market.
• Long-term gains with lower risk: Defensive stocks offer similar long-term gains compared to other stocks but with lower risk. This makes them objectively better investments.
• Utilities: Water, gas, and electric utilities are considered defensive stocks because people need them during all phases of the business cycle.
• Consumer staples: Companies that produce or distribute consumer staples or goods that people tend to buy out of necessity, such as food, beverages, hygiene products, and household items.
• Pharmaceutical companies: Shares of major pharmaceutical companies are historically considered defensive stocks as there will always be sick people in need of care.
• Real estate investment trusts (REITs): Apartment REITs are deemed defensive because people always need shelter. However, avoid ultra-high-end apartments, office building REITs, and industrial park REITs.

Focus on fixed-income investments

Defensive investment strategies are designed to protect your portfolio from losses rather than increasing its value. Fixed-income investments are a natural defensive move. They provide an income stream, and as long as the issuer doesn't default, your capital is safe.

US Government or Municipal Bonds

These are the safest fixed-income investments. They are, however, susceptible to interest rate risk. In an environment with rising interest rates, the rate paid by the bond will fall behind.

Corporate Bonds

A well-diversified selection of highly-rated corporate bonds will have higher yields than government bonds but with a very low risk of default. Bonds with higher credit ratings typically pay lower coupon rates.

Treasury Inflation-Protected Securities (TIPS)

TIPS are common government-issued fixed-income securities that protect investors from inflation. The principal amount of a TIPS bond adjusts with inflation and deflation.

Certificates of Deposit (CDs)

CDs are fixed-income vehicles with maturities of less than five years offered by financial institutions. They have a higher rate than a typical savings account and carry FDIC or National Credit Union Administration (NCUA) protection.

Mutual Funds

For those who don't want to select individual bonds, fixed-income mutual funds provide exposure to various bonds and debt instruments. They give the investor an income stream and professional portfolio management.

Exchange-Traded Funds (ETFs)

ETFs work like mutual funds but may be more accessible and more cost-effective for individual investors. They may target specific credit ratings, durations, or other factors.

Laddering Strategy

Investors can use a laddering strategy when investing in fixed income. This involves investing in a series of short-term bonds with different maturities, which provides a steady interest income. As bonds mature, the portfolio manager reinvests the principal into additional short-term bonds with maturities that extend the ladder. This method provides investors with ready capital, and they can take advantage of rising market interest rates.

Fixed-income investing is generally a conservative strategy with returns generated from low-risk securities that pay predictable interest. It is recommended for conservative investors seeking a diversified portfolio.

Frequently asked questions