How To Develop A Vaccine...For Your Portfolio

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It’s not as game-changing as a medical breakthrough, but the concept is similar

This week was certainly one we needed. Seeing the first people get vaccinated against Covid-19 is the kind of hopeful sign that has been lacking in 2020. Since this is an investment column, and since I am a big believer in risk-management in investing, I could not help but see some similarities.

Of course, nothing I write below compares to the life-and-death paradigm we are all living through this year. However, in celebration of this potentially-historic turning point, here are some thoughts on protecting your portfolio as we close out 2020.

As with any health issue, a vaccine does not guarantee that you would have contracted the ailment in question. People decline to get flu shots but don’t get the flu. But, taking certain preventive measures with health and wealth are worth considering.

Risk-managed investing

When it comes to your portfolio, I am glad to report that risk-management is very much in your control. That’s due in large part to the development over time of a wide set of tools to mitigate “the risk of taking a risk” in the public investment markets.

The most basic way I know to protect assets from the whims of the markets is, not surprisingly, keeping some of your portfolio in cash. That’s harder to do these days, with money market and CD yields near zero.

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Still, I am a big fan of cash as a use of some of your portfolio’s capital over shorter periods of time (days, weeks, maybe some months). If you have a discipline to your investment process, and part of that includes investing in things that pass your own investment criteria, there will be times when you just can’t identify enough good ideas to fill up 100% of your portfolio.

In those cases, what are you supposed to do, throw good money after bad, so to speak? I would argue that your cash position is simply a by-product of the rest of your process. Cash is an asset, just like anything else. And, even in a time when cash means no investment return, it can “vaccinate” you against rough markets, while stopping short of being an all-out timing tool.

Another option = options

The options market is another place to look for portfolio protection. However, that’s a whole investment beast to master on its own.

Options are “derivatives” in that their value is derived from a stock or ETF. If you can commit the time to understand an implement them, they are, pardon the pun, an option to consider.

ETFs (the hedge kind)

The “portfolio vaccination” method I consider to be most helpful these days is a sub-segment of the ETF market that I refer to as “hedge” ETFs. These securities trade on the stock exchange. However, unlike most ETFs, they are built in whole or in part to profit from a downturn in the prices of stocks or bonds.

This is an area of tremendous focus for the ETF industry right now. However, there are some traps here. Some hedge ETFs are very complex, and that smells like “surprise” potential to me. And not the good kind of surprise.

Others are more nuanced, but make sense to me as complements to the more traditional parts of your overall portfolio strategy. Some allocate between stocks they buy and others they short (a.k.a. “long-short strategies”) with the aim of profiting from the difference between the 2 parts of the fund.

Other ideas to consider

As I have written here in the past, you can also construct your own “pairs” of ETFs on your own, to try to “arbitrage” your way to positive returns. This is a separate discussion, but I invite you to find that article on Forbes.com, or contact me for a link to it.

Other hedge ETFs are more blunt about it. They use options, futures, swaps and/or other tools to bring sophisticated investing to a vehicle you can buy and sell on the stock exchange.

These “inverse” ETFs also need to be well-understood before you use them, since they tend to fall when the market goes up. And, while that’s what they are built for, the mathematics of loss are such that one should understand how they differ from traditional, “long” ETF positions.

To your (financial) health!

So, there are many ways to protect yourself from being “infected” by a bear market, or even more routine market swings. Your specific approach depends on the type of return experience and pattern you are comfortable with.

Because investing today means you have greater ability than in the past to target your own range of (realistic) potential outcomes from your portfolio. The defensive tools described here may help you pursue that.

Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors.