According to the most successful investors around, the key to achieving investing successful is not losing any money. This doesn’t really mean you should any holdings that start losing some ground. However, you should aware of some effective strategies that can protect your portfolio from losing.
Use Diversification
Diversification is among the most important cornerstones of the modern portfolio theory. During a market downturn, the MPT supporters believe that a well-diversified portfolio will outperform a concentrated one.
Investors create deeper and more broadly diversified portfolios by holding a large number of investments in more than one asset class, therefore lowering the unsystematic risks, which are the risks associated with the investments in the markets in general.
Use Assets with Low Correlations
According to experts, stock portfolios that have 12, 20, or 40 stocks can get rid most, if not all, unsystematic risks. However, systematic risk is always present.
The good thing is that you can still add non-correlating asset classes like bonds, commodities, currencies, and real estate to a bunch of stocks. The result is usually lower volatility and lowered systematic risk because of the fact that non-correlating assets get affected differently to movements in markets compared to stocks. Most of the time, when one asset goes down, the other goes up.
Overall, using non-correlating assets get rid of the highs and lows in performance, offering more balanced returns. That’s the theory.
However, in recent years’ evidence suggest that assets that were once non-correlating are now tracking each other, therefore reducing the strategy’s efficiency.
Use Stop Losses
Stop loss orders are your friend. They can protect you from falling share prices. For instance, hard stops involve triggering the sale of a stock at a fixed price that doesn’t change. Suppose you buy the stock of Company A for $10 per share with a hard stop of $9. This means that the stock will automatically be sold if the price dips to $9.
A trailing stop, on the other hand, is different in a way that it moves with the stock price and can be set in terms of dollars or percentages.
The supporters of stop losses believe that they guard you from rapidly changing markets. Opponents point out that both hard and trailing stops make the temporary losses permanent. That is one of the main reasons why any kind of stops needs to be well planned.
Use Dividends
Investing in dividend-paying stocks is arguably the least popular way to protect your portfolio.
Historically, dividends account for a huge portion of the stock’s total return. There are cases when it can represent the whole amount. Owning stable companies that pay out regular dividends is a tested method for delivering above-average returns.
When markets are going south, the cushion that dividends offer is important to risk-averse investors and commonly results in lower volatility. Additionally, studies also show that companies that pay generous dividends usually grow earnings faster than those that do not. The faster growth usually results to higher share prices that in turn generate higher capital gains.
Additionally, dividends are also great hedge against inflation. If you invest in blue chip companies that both pay dividends and possess the pricing power, you give your portfolio some protection that fixed income investments, save the Treasury inflation-protected securities (TIPS), can’t rival.
