MITIGATE RISK WITHOUT VENTURING ABROAD
To offset equity risk, a trader needs to diversify his investments. We are often told we need to invest abroad in order to minimize losses. But there are more creative ways to mitigate risk without putting your capital abroad.
Avoid companies relying on discretionary income. Corporations and stocks specializing in necessities tend to outmatch their counterparts. Those who depend on excess discretionary income won’t be able to withstand consumer pressure, unless they are in the business of selling foods and drugs. People need those to meet their needs, regardless of the prevailing economic condition. Also, sin stocks tend to fare in market turmoils. They seem to emerge when other stocks are regressing.
Buy bonds or money market instruments. For the record, stocks have surpassed other investment vehicles over the last 100 years. But there are some cases bonds and money market instruments have outmatched equities. If looking for long-term capital appreciation, keep a considerable percentage of portfolios invested in equities. But inject some bonds to counter the losses. There is no fixed percentage of bond holdings in a portfolio because it depends on numerous factors, including income needs, financial goals, market conditions, and risk appetite. But bear in mind that one should retain a little cash reserve to hedge against a market correction.
Diversify with large cap stocks. Investors in general favor quality, large cap stocks in times of economic downturn. These companies have hefty cash reserves, generate higher income and cash flow, and more diverse in terms of economic footprint than mid cap or small cap counterparts. Having said that, they can weather trying economic times. Two things: Investors should allocate a part of their assets toward these securities or limit exposure to bleeding-money and/or development stage firms, especially when macroeconomic conditions start to degenerate.
Hedge with options. When stocks underperform, the natural inclination is to liquidate all or portion of it. But investors can also alleviate the risk through options by buying puts on a specific index or stock, or sell call options on some equities and/or indexes. Options are not for everyone. Before considering purchasing or selling any option, one should fully understand the usage of options and the extent of its leverage, and that certain securities have no or do not trade underlying options.
Rebalance or diversify. A quick refresher: Rebalancing is maintaining a particular asset allocation within an investment account, while diversifying is forming a mix of investments in a portfolio seeking to reduce risk. Investors must diversify their portfolio first before rebalancing a portfolio. Several investors construct their holdings in a wrong way, placing too much weight in a distinct sector. Or, they follow a balanced investment strategy, having sufficient exposure to broad sectors within the economy, but fail to rebalance it according to the overall market activity. For holdings to remain balanced and proportionate over time, investors should consider holding stocks in various sectors. That way, investors won’t be overly focused in just one sector.
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