How to protect your money when the market falls
Markets never go in a straight line. In a bull market there will be corrections. In a bear market there will be rallies. The value of your investment, as we always say, can go down as well as up.
While market falls are an inevitable part of investing, you can protect yourself to some extent. With smart asset allocation, you can put your portfolio in a good position to potentially fall less than the wider market. This way, when the market bounces, you may be rising from a higher level. This is known as downside protection.
Learn more: How to invest when the market is volatile
Reduce your equity exposure and diversify
Investors wishing to reduce their risk should consider diversifying some of their equity holdings into other investments. You could hold a variety of asset classes such as bonds; infrastructure; property; cash; absolute return (a type of fund that will try to create a return in all market conditions); and even gold.
Adding these types of assets can help reduce the overall risk of your portfolio in two ways. Firstly, funds such as low risk absolute return, high quality bonds or even cash are typically less volatile than equities. Secondly, some of these assets are uncorrelated or lowly correlated with equities. This means that if the market tumbles, they may fall less or they may even rise. Of course, it’s important to understand these assets could also fall as much or even more than, the market, but the point is they provide diversification because there is minimal connection between their movements and the broader stock market.
Recently, correlations between asset classes have been increasing and this has made constructing portfolios more difficult. Bonds and equities used to behave very differently, for example, but now their performance can be quite similar. The prices for perceivably ‘safer’ assets, such as government bonds, are also high at the moment.
Some assets that typically remain relatively uncorrelated to equities are physical gold, cash and certain types of absolute return funds1.
Defensive funds within each asset class
You can also help protect your portfolio by choosing more defensive funds. Some equity funds have a bias to cyclical industries such as banks, which are dependent on the economy. These funds are more aggressive and are likely to fall more than the market during a sell-off, but rise more than the market on the way up.
Conversely, there are funds that invest in more defensive non-cyclical industries, such as utilities or healthcare. Specialist equity infrastructure funds are another example. Typically, these funds will be less affected by the wider economy and will therefore fall less than the market in the case of a sell-off. They do, however, tend to lag if the market rises quickly. Investors wishing to reduce risk could consider adding some of these more defensive funds into the equity portion of their portfolio.
For bonds, consider high quality, low duration funds that are less sensitive to changes in interest rates. You could also look at certain strategic bond funds that have the tools to react to changing market conditions.
Go global
You can also diversify globally. Investors typically have a home nation bias, but by spreading assets across different countries, you become less exposed to the risk of one currency or country. The Brexit vote aftermath has shown how important this is, with many overseas funds taking large jumps in sterling terms following our currency drop.
The US dollar is typically treated as a ‘safe haven’ asset, which will offer some protection in times of market uncertainty. Always remember that the mix of asset classes in your portfolio and the percentage you allocate to each will depend on your personal attitude to risk and return. Consider what level of equity and other exposure you are comfortable with before building or amending your portfolio. If you require individual investment advice you should contact a financial advisor.
1FE Analytics, Bloomberg Gold Sub vs MSCI World vs MSCI United Kingdom vs Bank of England base rate correlations. 06/09/2001–05/09/2016. Data accessed 06/09/2016
This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions.Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice.Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.
