SHIELD YOUR PORTFOLIO FROM VOLATILITY
It is normal for the market to reach a key psychological level and then decline. But many investors feel a bit anxious about the market volatility. Unfortunately, an investor cannot totally avoid it, but there are ways to protect his portfolio from volatility.
But before anything else, investors must become familiar with CBOE Volatility Index (VIX), a metric gauging the anxiety level in the investment markets. The Chicago Board of Exchange introduced the index in 1993, seeking to display the market’s expectation over the next 30 days. Dubbed as the investor fear gauge, VIX reacts in real time and is computed from both calls and puts.
Here are some ways to shield a portfolio from volatility:
Hedge. Hedging is like obtaining an insurance to protect yourself from any danger. For instance, the market is bearish and you have substantial stock holdings. One option is purchase a put option, with a strike price lower than the purchase price. You won’t lose money on any move below the strike price. Another is short selling a stock and buying put options on index funds such as SPDR S&P 500.
Low Beta. Beta measures a security’s volatility. Expect a stock to move at the same rate as the S&P 500 if it carries a beta of one. Stocks with beta higher than 1.0 are more volatile than the market index, while those lower than 1.0 are less volatile. In case of extreme market volatility, pick low beta stocks that pay a dividend.
Stay Out. There are instances trading volume in the market drops substantially. For retail investors, they need to find out when the market is too volatile and exit into safe haven instruments. If you have a long-term portfolio, do nothing and wait for the market to stabilize. In the meantime, depend on safe, consistent dividends.
Stick with the Index. As the efficient market hypothesis states, it is impossible to outmatch the overall market, meaning individual stock picking will not generate better results in the long run. So what is the best way to make money? Invest in an index fund. Especially in times of extreme volatility, do not expect stocks to act rationally. Better stay with the index.
Expand Time Horizon. It is a losing game for many investors during market turmoil. You can increase your time horizon until the markets calm down. When the market is at its lowest, look for undervalued stock or purchase an index fund. Hold those positions for at least a year, unless something drastic occurs. The longer the investment, the easier it is to generate money. Every dividend payment reduces your stock’s cost basis.