How to Manage Your Portfolio for Market Volatility
In a volatile market, it is prudent to protect your portfolio for wild value vacillations. While you want to minimize down side, you need to be careful not to compromise growth prospects, i.e. there is no point in investing for breaking even. We will walk through couple of broad themes below.
Things You’ll Need
- Investment portfolio
- Brokerage account
Ways to Manage Your Portfolio for Market Volatility
a. This is an effective way to reduce downside of your portfolio. Think of it as insurance against loss.
b. A popular technique is to buy put option (i.e. a right to sell at a given price in a future timeframe) against an index that closely matches your holdings or against the stocks that you own. For instance, fund managers often buy put option against S&P 500. Rather than buying put option against the index itself, it is easier to buy against the respective tracking ETFs (e.g. SPY).
c. Depending on the worth of your portfolio and the insurance premium you are willing to pay for put options, you should calculate the number of contracts you want to buy. Remember that each put contract gives you the right to sell 100 underlying security, which in this case SPY. So if the market falls, you can sell your put options for profit to offset loss.
You want to spread your assets among the following broad categories, depending on the risk vs. return appetite.
When investing in stocks, you want to diversify into different sectors, market caps, growth/value and domestic/international/emerging market.
ii. Real Assets
You should take the value of your home, rental properties and REITs into consideration when diversifying. You should also consider diversifying into other real commodities (such as Oil, Precious metals and Industrial metals).
iii. Fixed income
Bonds (treasury notes, inflation protected bonds (i.e. TIPS), state municipal bonds, corporate bonds) are a great way to minimize risk with modest returns.
The phrase “cash is king” applies at any time. You should consider parking a sizable chunk of your portfolio into money market account or CD. Depending on the interest rates and short term prospects of your currency, you may want to diversify into other world currencies through a FOREX trading account or currency ETFs.
You should periodically evaluate the macro trends of the economy, your personal fiscal situation and the performance of your account in employing the above techniques.
Tips and Warnings
- When calculating net worth for diversification purposes, please take all your accounts (even your retirement 401k) into consideration.
- Age (the idea is the younger you are the more risk you can take, for a greater return potential)
- Risk (basically your appetite for return and what you are willing to stomach)