Developing Your Defensive Investment Strategy

What is a defensive investment strategy exactly?

In short, defensive investing is an investment philosophy that entails a number of strategies to minimize risk, and protect your wealth, when markets are in a downturn and maximize profits when markets are in an upturn.

If you’ve been investing for any amount of time in any capacity, you know that markets are periodically prone to drastic up and down swings. They are constantly in flux. A defensive strategy, above all else, aims to keep you from losing money when markets go south and transitions to an opportunistic stance once markets go north again, figuratively speaking. What’s more, we know by now, with over 100 years of market history and analytics, that markets tend to follow cyclical patterns. That is, there’s a frequency of high and low market performances. As such, these patterns (while not perfect) have been effectively instructive in our efforts to position clients defensively as we head into downturns and opportunistically when headed upward again.

These predictions aren’t based on arbitrary timing or a ‘gut feeling’ about where the market’s headed. That sort of pseudo-scientific approach is a dangerous game to play. You may get lucky, but chances are you’ll end up with unnecessary losses. A conservative and defensive approach to investing recognizes that upward and downward trends tend to be prefigured by a set of very specific market conditions that signal these transitions. This is why, if you’re serious about your investments, it’s vital that you watch the markets daily. Just because market analytics have identified patterns in market trends does not mean these trends are perfectly timed. Markets are dynamic, contingent, and sometimes volatile.

Keeping a close eye on your investments is imperative.

So, perhaps your next question is, “How do I correctly position defensively in anticipation of a downward market trend?” Yes, a very good question. I can offer you two telltale signs markets are fording troubled waters.

Historically, paying close attention to markets’ 200 day averages can help you glean insights about the general directions markets are headed.

When markets pass below their 200 day averages, you can expect volatility to ensue. We saw this trend play out last August, followed by sporadic market movements in September initiating a market decline.

Additionally, you’ll also want to pay close attention to divergent trends. Typically, in healthy, rising markets the S&P 500 and Barclays U.S. Corp. High Yield Index show strong parallel correlations, tending to run in alignment. However, recently the two indices have shown a divergence: the Barclays U.S. Corp. High Yield Index plateaued while the S&P 500 continued to ascend. The last time this divergent corollary occurred in the late 1990s and mid 2007, it heralded drastic market downturns.

If you find yourself at the brink of a market decline, what are you, the investor, to do?

Conventional “buy and hold” wisdom might suggest that you should wait it out; the markets will recover in time. And if you are young enough, with years ahead to accumulate assets for your retirement, this might make more sense. But if you are about to enter or are already in retirement, you’ll want to take a more active approach with your investments in downward markets – just as pensions, charities and endowments have done for decades. One of the most effective defensive strategies for combating depreciated markets is to transition your investments into cash equivalents, non correlated assets such as treasuries, or utilize inverse ETF positions (that can profit from negative movements) while downward trends plays out.

Once markets begin to show signs of recovery, you can begin to move your available investment capital back into the markets with decreased risk and higher likelihood of returns.

All that having been said, should you feel unsure of your ability to properly navigate during uncertain market conditions…don’t worry; you’re not alone. In fact, it’s a very prudent thought, which is why I encourage those interested in positioning themselves “defensively in bad markets, yet opportunistically in good” to do as the large institutional investors do: hire someone to do it for them. This is what we do for clients every day by partnering with some of the country’s most elite private wealth managers that have had an impressive history utilizing defensive and opportunistic strategies in order to help clients’ investments achieve their full potentials.   


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