Protect your portfolio from volatility.
Managing portfolio risk is always important but it can trigger a new sense of urgency for investors when stock market volatility increases. “It’s always important to be aware of (the) risk but in the later innings of the cycle, it’s especially timely,” says Sarah Henry, portfolio manager of the dividend performers strategy and the dividend performers balanced strategy at Logan Capital Management in Ardmore, Pennsylvania. Henry says slowing growth indicators and the potential for incremental costs from trade negotiations could shake business and consumer confidence. Those effects could carry over into the market, heightening risk. Portfolio risk management isn’t a perfect science but there are things investors can do to adjust and adapt when the market begins to shift.
Consider hedged equity.
Hedged equity funds are mutual funds that are designed to minimize the effects of volatility on investment returns. Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Michigan, says these types of funds can help reduce the downside capture for portfolios that include large cap U.S. equity positions. Funds are typically actively managed, with holdings concentrated in stocks that lean toward naturally lower volatility, with a long term goal of achieving capital appreciation through changing stock market cycles, Milan says. JPMorgan Hedged Equity Fund (ticker: JHEQX) is a good choice for a hedged equity position, as are funds that include high quality stocks with solid fundamentals and rising dividends. JHEQX currently has a five star rating from Morningstar and is categorized as high return, low risk.
Adjust for timing.
Retirement time lines are another factor to consider in managing portfolio risk. Ken Moraif, senior retirement planner at Retirement Planners of America in Plano, Texas, says the biggest threat isn’t missing out on some returns — it’s participating in big losses. The potential for negative impacts is heightened for individuals who are getting into the last five to 10-year ramp-up to retirement. “Interest rates are probably the biggest threats to investors at this time because they affect almost everything in the economy,” Moraif says. Dialing back equity exposure to a maximum of 60% is something investors who are retired or close to it should consider if they’re concerned about the side effects of rate fluctuations, he says.
Diversify against uncertainty.
Tariffs and the possibility of an extended trade war can add to investor worries, as do inflation and movements in the yield curve. The yield curve is a way to gauge how bond investors feel about interest rate risk and it’s often used as a recession indicator. There’s always the potential for something unexpected that could trigger negative market reactions. Segmenting assets between safety and risk is a good move, says Derek Gregoire, co-founder of SHP Financial in Plymouth, Massachusetts. “Take advantage of conservative investments like cash, money markets, fixed annuities and bonds,” he says, since they can offer stability in a portfolio when volatility rises. For instance, investors may choose to divvy up five to 10 years of retirement income in safer vehicles, with the remainder in more aggressive investments. Avoid becoming overweighted and remember that time in the market is more important than timing the market, Gregoire says.
Look at alternatives.
A well-rounded portfolio risk formula may include investments that aren’t correlated to Wall Street. Milan says market neutral funds, such as Nuveen Equity Market Neutral Fund (NIMEX), fit the bill, as do private limited partner funds and hedge funds that hold tangible assets such as real estate. Nofee fixed index annuities could be a good substitute for traditional fixed income positions, Milan says, since they offer principal protection. An indexed annuity that’s designed to follow a low volatility strategy could be a strong choice if it allows for upside potential, with 100% downside protection. Investors may get more insulation against credit and interest rate risk, which when combined, could challenge the conservative position of traditional fixed income investments.
Control emotional thinking.
Proper diversification is important but it’s not a true magic bullet for managing risk, says David Bunin, principal advisor at Interlock Financial. A well-diversified portfolio could have lost between 20% to 30% of its market value during the pullback from the last major recession, he says. The better way to handle portfolio risk management is to build it into the portfolio construction process. This means conducting a thorough risk analysis and utilizing core strategies such as dollar cost averaging and owning noncorrelated assets. With dollar cost averaging, the same amount of money is invested on a consistent basis. This type of approach can help remove emotional roadblocks when making decisions during periods of elevated volatility. Avoiding overreactions to stock market headlines and sticking to the plan can make navigating rough spots easier for investors.
Lean toward liquidity.
Duration risk is something else to plan for, as certain investments such as bonds may be more sensitive to stock market changes over time. Patrick Healy, founder and president of Caliber Financial Partners, says having some cash on the sidelines allows investors to take advantage of selloffs and potentially score some bargain buys when valuations are depressed. In that type of scenario, dividend producing stocks Procter & Gamble (PG) or Coca-Cola (KO) could be a good choice because they tend to be resilient and trade well even during periods of declining interest rates. Healy says holding these types of stocks, along with blue chip companies such as Johnson & Johnson (JNJ) or Walmart (WMT), which have sustainable cash flow and the ability to grow earnings over time, can offer a buffer against downside risk.
Wall Street rallies can be encouraging but they’re also an opportunity to rethink equity holdings, says Kristopher Martin, an associate and a client advisor at Miami-based Element Pointe Advisors. “Moving into large cap stocks and away from small caps is a great way to reduce portfolio risk,” he says. “It’s a low risk asset class and will maintain the best liquidity in down markets during periods of illiquidity.” Martin points to the Russell 2000, which tracks small cap stock performance, as an indicator of a potentially broader market trend toward an eventual recession. Since small caps tend to be more sensitive to recessionary environments, making a move now toward increased large cap exposure could add defensiveness to a portfolio moving forward.
Strategies to manage portfolio risk:
— Consider hedged equity.
— Adjust for timing.
— Diversify against uncertainty.
— Look at alternatives.
— Control emotional thinking.
— Lean toward liquidity.
— Large caps.
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