10 Ways to Build a More Defensive Portfolio

In light of current economic conditions, we at FaithBasedInvestor.com are starting to go into “defensive” mode.  During upward bull markets, a little offense goes a long way.  However during times of high volatility and downward momentum, it is often best to be safe rather than sorry.  That is where a good “defense” comes in handy.  

In team sports, especially football, defense often wins championships.  That is why we wanted to show you ten ways you can add a little “defense” to your portfolio strategies.

1.  Load up on cash & money market accounts.  Any defensive strategy should have loads of cash to take advantage of any future prime opportunities as well as to protect against the downside.  These accounts may earn relatively small returns but are considered a safe haven.  Most people wished they had a whole lot more cash in their portfolios during the 2000-2002 stock market crash as well as during the financial crisis of 2007-2009.   We believe right now is a prime time to be heavy in cash.

2.  Consider short-term U.S. treasuries (1-3 years max).  Yes, we are not too bullish on the long-term prospects of U.S. debt, but short term treasuries like SHY, can offer a bit more yield than a money market.  Additionally as rates rise, the yield on this ETF will also rise.  Short-term treasuries provide a minimal return so they should only make up a relatively small portion of the overall portfolio.  However these investments will add stability to your portfolio. T

3. Consider inflation-protected securities.  Inflation can significantly reduce your returns over time.  Whenever I consider an investment I look at taxes and inflation. Treasury Inflation-Protected Securities or TIPS TIP provide a hedge against inflation as they track the consumer price index (CPI). The price of TIPS is adjusted to keeps pace with inflation.  Another inflation protected to consider is one that tracks world inflations such as WIP.

4. Consider stable foreign currencies.  In order to hedge against fiat currencies (those not backed by a precious metal) that are relatively unstable at this juncture, consider more stable currencies like the Swiss Franc FXF and Australian Dollar (FXA). With the U.S. dollar and Euro in crisis mode, more stable currencies can provide some much needed protection.

5. Consider adding more corporate bonds. Look for stable companies that have a solid balance sheet and paying a good yield. By purchasing a company’s debts rather than its stock, you have less upside potential but often more stable returns.  These bonds typically pay a higher return than government or municipal bonds because of their higher risk.  By carefully researching the credit ratings of companies before purchasing their debt, you can often minimize your risk. I am not a big fan of bond mutual funds, but you can look at ETFS that track bond indexes or consider purchasing individual corporate bonds.

6. Consider purchasing “defensive stocks”.Stocks with low volatility and consistent dividends can provide some defense to your portfolio. These types of stocks will have the potential to provide both growth and income to your portfolio.  Keep in mind, most equities tend to rise or fall together.  More defensive industries like health care, energy, consumer staples, and utilities may hold up relatively well during a market sell-off, but they still can fall in value during bear markets.  To minimize potential losses, look for companies that do well during recessionary periods.  Right now, consumers are looking to save money any way they can, but they are still buying food, toilet paper, and toothpaste. Stocks should represent a small percentage of a defensive portfolio because these types of investments still go down during bear markets and entail higher levels of risk.

7. Consider buying some physical gold and silver.Physical gold and silver always have long-term value and are always in demand.  These investments have traditionally kept pace with inflation and are a great holding to have in times of crisis.  Additionally these assets have low overall correlation with most other investments providing you additional diversification.

8. Consider commodity ETFS that have lower correlation to the equity and bond markets.  You can look at agricultural ETFS like DBA or a more diversified commodity ETF like DBC.  You could also consider an energy commodity ETF like OIL, a gold ETF like GLD or silver ETF like SLV.  These commodities may have downside risk, but when combined with stocks and bonds can lower the overall portfolio risk and flctuation.

9. Consider hedging instruments for a portfolio of your portfolio.  You can look at inverse ETFS that short the market one-time like SH for the S&P 500 or if you are more confident of a market down turn you may choose to short the market 2x like an ultra-short S&P 500 SDS.  You can also short long-term treasuries by using an inverse ETF like TBF or currencies you may think may drop in value like the Euro EUO.  Keep in mind these hedges should be monitored closely and you should have an exit strategy as they can quickly move against you.

10. Don’t forget to take some risk off the table.  Now may be the best time to lock in some gains (many investments have significantly increased in value the past few years).  Look to reduce your risk by selling off your more risky, volatile positions and shift into some lower risk, less volatile positions.   This may go without saying, but always consider the tax implications before making such moves.  Though you don’t want to pay higher taxes, don’t let taxes prevent you from making the right investment decision. Locking in a gain while times are good and paying taxes is better than worrying about the taxes and seeing your risky investments take a nosedive during the next market downturn.

As you can see there are many ways to add some defense to your portfolio.  There are times where the markets are undervalued and it pays to take risk in effort to get better returns.  However, during times like today, where we believe the markets are overvalued, it is often better to make moves sooner rather than later to minimize potential losses and protect your portfolio.