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Protect Your Portfolio With A Little Defense

February 24, 2011 by Jon

Defensive PortfolioWhen you see market corrections or moves like we have the past few days, things have a tendency to look more ominous than they really are.  The markets don’t like uncertainty and that is exactly what they’re getting.  With uncertainty you get high price fluctuations in stocks, bonds, and commodities, which is great for traders but tough to watch for the average investor.

On top of all this is the looming inflation rise.  One of the most overlooked aspects of investing is inflation.  In the past year inflation has become a daily discussion on all the major business news sites.  If you listen to the experts you get a multitude of opinions about inflation and where it’s heading.  All the economists have there own opinion as to when a rise in inflation will occur, but rather than waiting for it to happen, we should be protecting our investments from the coming inflation rise and uncertainty.

Locking In Profits

During these uncertain times it’s always a good idea to lock in some profits.  It’s the easiest way to protect your portfolio from losses.  The worst thing that could happen is that you make money.  Doing this puts extra cash on the side to invest back into the market at a more attractive time.

Gold

During times of uncertainty and inflation fear, gold is a safe haven.  Gold was a great investment in 2010, largely due to the future inflation concerns.  Put simply, if the inflation rate is 3% and you only made 2% on your savings or investments, you lost money.  To counter this, it’s a good idea to always have 5-10% of your portfolio in some gold investment vehicle.

Outside of actually buying gold bullion, there are several investment options including the SPDR Gold Trust ETF (NYSE: GLD) or through an actual gold miners stock.

Bonds

Bonds are a great investment for anyone looking for a fixed income source.  They tend to be very popular with retirees because of this.  High inflation however can eat into the value of that income quickly if your not protecting yourself.

A good protection against inflation with bonds are I-Bonds and TIPS (Treasury Inflation-Protected Securities).

I-Bonds are U.S. Savings Bonds that have a fixed interest rate and a variable interest rate.  The fixed rate is set when you buy the bond while the variable rate is adjusted twice a year based on the inflation rate.

TIPS on the other hand have a fixed interest rate with the principal that is adjusted for inflation.  As inflation rises the principal value rises, thus the interest payments rise also.  For more information about I-Bonds and TIPS head over to TreasuryDirect.

Commodities

Like gold, commodities tend to be a safer haven during high inflation periods.  The premise is simple.  As the price of goods rise, an investment in the materials to make those goods will also rise.  There are several ways to invest in commodities, the easiest is through an ETF of a particular commodity or buying stock of the actual commodity company.

One thing to keep in mind though, during times of high uncertainty in the market, commodities prices tend to see large swings in value.  This can provide profit opportunities for traders, but possible headaches for the average investor.

Stocks

When looking for defense with stocks, it depends more on a diversified basket of a particular type of stock.

During times of uncertainly the stocks that tend to provide the best protection are high quality, large cap, dividend paying stocks.  These stocks tend to see a much lower price fluctuation, especially compared to the volatile small and mid cap stocks.  By holding dividend paying stocks, you allow for dollar cost averaging during the longer periods of uncertainty.

As far as inflation protection is concerned, the option is to buy companies that have “pricing power”.  “Pricing power” is the ability to raise prices without seeing a drop in demand for the product, material or services.  As we mentioned earlier commodity companies are a good example of this.  What products are you willing to pay more for rather than buying a cheaper alternative?  The companies making those products are a good start.

When it comes to investing, nothing is guaranteed.  Protect your investments from the roller coaster swings in the market.  Implementing a few of the suggestions above will help ease the day to day swings in your portfolio.

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