about 3 years ago • 3 mins
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What return do you need to recover from an 80% loss? Not 80% – instead, a 400% gain is required to get back to where you started. That’s more than double bitcoin’s blockbuster 2020 performance. Lose 50%, and you’ll have to double your money to get back to square one; but even leading hedge fund Renaissance Technologies has only managed to generate a 66% annualized return over the last 30 years. Your best bet is therefore to avoid large losses in the first place.
Losses impact performance in an asymmetric manner: large drawdowns make it difficult to get back on track for long-term goals. But you’ve also got to take risks to make meaningful returns. Here are three ways you can strike a good balance and add defensiveness to your portfolio while remaining fully invested.
1. Diversify across asset classes
Ray Dalio, founder of Bridgewater Associates – the world’s largest hedge fund – recently wrote that “diversifying well is the most important thing you need to do in order to invest well”. Ensuring your bets are sufficiently well spread can dramatically reduce your risks without massively impacting potential returns. That’s having your cake and eating it. Diversifying isn’t just about increasing the number of stocks you own, however; it also means making your portfolio resilient in the face of a highly uncertain future. Have at least some exposure to assets that should perform well if stocks struggle: gold, government bonds and the US dollar come to mind. And as mentioned in yesterday’s Insight, alternative investments could be worth exploring too.
2. Invest in defensive sectors
You can also improve your D by swapping part of your basic S&P 500 (or other major market index) exposure for a focus on stocks in defensive sectors such as consumer staples, healthcare, and utilities. (You can do this easily through sector-specific exchange-traded funds.) These don’t do as well as the overall stock market when the economy’s growing, but they come into their own when recessions inevitably hit. In March this year, for example, those three sectors outperformed the S&P 500 by around 40%. Even when times are tough, people still need eating, heating, and healing.
3. Buy protection
Consider looking at the options markets as a way to put in place strategies that protect you against outsize portfolio losses. One such tactic involves buying “put” options on stocks or high-yield company bonds: their value rises when stocks fall, helping offset any losses elsewhere. Or else you could buy “calls” on your diversifying asset classes, such as gold or government bonds. While options can offer the potential for attractive asymmetry – you only exercise them when it benefits you – this comes at a price, with the premium paid for such “insurance” typically quite high.
How you combine and implement these tips will obviously depend on your individual risk tolerance and return objectives. Nevertheless, thinking about and planning out your defensive strategy before a crisis comes a-calling is a good move for every investor. Just like in a sports match, preparing a strong defense will help head off the potential for large losses – and avoiding falling too far behind may prove key to achieving your long-term goals. At the end of the day, you’re not looking to sell tickets to a spectacle; you’re looking to win the championship!
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.