Playing Defense: Three Stock Strategies to Help Control Risk
Defensive stock strategies can help a portfolio better weather an economic downturn or bouts of market volatility without sacrificing all the growth potential of equities. If you are nearing retirement or just want to lower your risk exposure, these strategies may help you manage risk while maintaining an appropriate equity portfolio.
All stocks are volatile to some degree, but some have been less volatile historically than others. Mutual funds and exchange-traded funds (ETFs) labeled “minimum volatility” or “low volatility” are constructed with an eye toward managing volatility.
One commonly used measure of a stock or stock fund’s volatility is beta, which is typically published with other information about an investment. The stock market as a whole (represented by the S&P 500 index) is considered to have a beta of 1.0. In theory, an investment with a beta of 0.8 might experience only 80% of market gains during an upswing and only 80% of losses during a downswing — and thus would have less ground to regain when the market turns upward again. Although low-volatility stocks may have lower growth potential when the market is booming, they can produce higher long-term returns under some market conditions (see chart).
Whereas stock prices are often unpredictable and may be influenced by factors that do not reflect a company’s fiscal strength or weakness, dividend payments tend to be steadier and more directly reflect a company’s financial position — and can add to a stock’s total return regardless of market conditions. Comparing current dividend yields, and whether companies have a history of dividend increases, can be helpful in deciding whether to invest in a stock or a stock fund.
The flip side is that dividend-paying stocks may not have as much growth potential as non-dividend payers, and there are times when dividend stocks may drag down, not boost, portfolio performance. For example, dividend stocks can be sensitive to interest-rate changes. When rates rise, the higher yields of lower-risk, fixed-income investments may become more appealing, placing downward pressure on dividend stocks.
Some business sectors tend to be less affected by economic changes because companies in these sectors produce goods and services that people typically buy regardless of their financial situations. Examples of “defensive sectors” include consumer staples (which comprise food, beverages, and household necessities such as toilet paper), utilities (water, gas, and electric), and health care. On the other hand, companies in “cyclical sectors” such as consumer discretionary and durable goods sell products that people may forgo during tough times.
Although defensive stocks or sector funds may help stabilize your portfolio, keep in mind that every business cycle is different, and macroeconomic events or unexpected geopolitical shocks can sometimes disrupt regular trends. A portfolio invested too heavily in a particular industry or market sector — even a defensive sector — may not be sufficiently diversified and could be subject to a significant level of volatility and risk.
These three strategies share characteristics and may overlap — for example, low-volatility funds are often heavily invested in dividend stocks and defensive sectors. Before you put any of these strategies into action, make sure the overall balance of your portfolio remains in line with your goals, time frame, and risk tolerance.
The return and principal value of all investments fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Investing in dividends is a long-term commitment. The amount of a company’s dividend can fluctuate with earnings, which are influenced by economic, market, and political events. Dividends are typically not guaranteed and could be changed or eliminated. Low-volatility funds vary widely in their objectives and strategies. There is no guarantee that they will maintain a more conservative level of risk, especially during extreme market conditions.
Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.