January 18, 2022

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7 Ways to Hedge Your Portfolio Against Volatility

Investors can ease the effects of volatility.

As recession fears mount and global economic growth halts, the stock market remains in flux. Volatility is more common as economists, market strategists and asset managers face hurdles in estimating future GDP and profit margins. The market could retest lows more than once as the impact of the coronavirus pandemic remains unprecedented. Determining an investment strategy on how to invest when the market remains extremely volatile will lower your risk and avoid large losses. “Now is a good time to assess your risk tolerance and make sure you’re on track to meet your long-term goals in the current environment,” says Rick Swope, senior strategist of investor education at E-Trade. Here are seven investment strategies to add to your portfolio to lower volatility.

Stick to cash.

Cash investments such as savings accounts, money market accounts and certificates of deposit offer a “respite from the ups and downs of the market,” says Greg McBride, chief financial analyst for Bankrate, a New York-based financial data provider. The ongoing issues with the coronavirus, oil price war and liquidity stress drove investors to cash, says Chris Osmond, chief investment officer at Prime Capital Investment. Cash not only provides agility during these uncertain times, but it also dampens volatility. “Cash on hand allows either a long-term investor or junk bond trader to potentially capitalize in these volatile times,” he says.

Stick to gold miners.

Gold miners like Barrick Gold Corp. (ticker: GOLD) and Newmont Corp. (NEM) should provide some stability and upside in the next few quarters as the government bails out consumers and businesses because of the pandemic, says Ron McCoy, CEO of Florida-based Freedom Capital Advisors. “The Federal Reserve really has no choice but to continue to inflate their way through this mess, and gold miners should benefit,” he says. “Their valuations are compelling given the current environment, and we believe we could see a replay of 2008-2009 in the mining sector that led the markets higher coming out of the downturn.” Investors who prefer diversification over choosing specific gold miners could allocate money into SPDR Gold Trust (GLD), the largest gold-backed ETF.

Add alternative investments.

Investors should diversify their portfolios with a healthy allocation of 20% to 30% of illiquid real asset investments with funds in real estate, infrastructure and natural resources to act as a ballast, says Michael Underhill, chief investment officer at Capital Innovations in Wisconsin. “If investors can take a long-term view like these endowments, investors may have a chance of beating the odds of generating average individual investor returns of 2% over 20 years from buying high and selling low,” he says. Cell towers, data centers, single-family rentals and apartments are good hedges against the eventual recession. “We believe that real estate, in general, will see strong investor support in the medium term due to the increased need for yield alternatives,” Underhill says.

Invest in stocks.

Shore up your portfolio with defensive sectors such as consumer staples and utilities with a consistent nature of business, Swope says. “Keep in mind that with risk comes reward, so returns in these areas of the market may be lower compared to traditional growth sectors like technology,” he says. Consider adding an ETF that focuses on companies with a strong return on assets growth such as iShares Edge MSCI USA Quality Factor ETF (QUAL), says Derek Horstmeyer, an assistant finance professor at George Mason University. “These are typically denoted as ‘quality’ ETFs and focus on companies that are profitable,” he says. “We know that profitable companies exhibit much lower volatility than nonprofitable ones, so this is a good thing to shift into during a time like this.”

Utilize options.

Utilize options because put buyers can insulate themselves from some or all of the downside in a portfolio, says Steve Sosnick, chief strategist at Interactive Brokers. Covered call writers can generate income, but it doesn’t reduce downside. “More sophisticated strategies like spreads and dollars can be used to profit from the recent volatility spike,” he says. “There is a certain element of shutting the barn door after the horses left in each of these strategies. But that requires counterintuitive thinking — being fearful when everyone is greedy.” One way investors can help protect themselves in volatile markets is to consider incorporating options, Swope says. “Options can hedge existing positions in your portfolio or the portfolio in its entirety to help reduce risk.”

Buy short-term government bonds.

During times of market uncertainty, it can make sense to have a substantial portion of your portfolio allocated to Treasury bonds. While Treasurys can provide ballast to market volatility, they are not good long-term investments to keep pace with inflation, says Daren Blonski, managing principal of Sonoma Wealth Advisors. A broadly traded ETF focused on short-term Treasurys is BlackRock’s iShares 3-7 year Treasury Bond ETF (IEI). This ETF has a low expense ratio at 0.15% and trades at high volumes. “We have learned with the recent sell-off in the markets that it’s critical to make sure the ETFs you’re investing in have large volumes and tight spreads, meaning the ask and bid trade closely together,” he says. “Otherwise exiting large ETF positions can prove challenging in fast-moving markets.”

Add investment-grade bonds.

By adding assets that have lower volatility to equities, you can reduce portfolio volatility. However, by adding uncorrelated or lowly correlated assets, portfolio volatility can also be reduced, says Jodie Gunzberg, chief investment strategist at Graystone Consulting, a Morgan Stanley business. The assets that remain uncorrelated to the S&P 500 are U.S. aggregate bonds, U.S. mortgage-backed securities, Treasurys and Treasury inflation-protected securities. Investment-grade bonds have far lower volatility than stocks and are generally uncorrelated to stocks, she says. “Bonds have held performance relatively well in 2020 with a year-to-date return of 3.3%,” she says. “There is a chance corporate bonds may become more correlated to equities if the economic turmoil impacts the credit.

Ways to hedge your portfolio against volatility:

— Stick to cash.

— Stick to gold miners.

— Add alternative investments.

— Invest in stocks.

— Utilize options.

— Buy short-term government bonds.

— Add investment-grade bonds.

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