Basic Guidelines to Decrease Portfolio Risk

With US economic data showing increased weakness and markets still near all-time highs, many clients are asking for ideas to manage risk in their investment portoflios. Below, we put together my list of ideas that we often discuss with clients.

Substitute ETFs for individual stocks to reduce individual stock risk –  For example, you may decide that you want to maintain some technology exposure; rather than holding a couple of individual names, you could consider buying a tech ETF, such as the iShares US Technology ETF (IYW), or instead of a large growth stock, consider a large growth ETF, like the Invesco QQQ Trust (QQQ), which are both in a strong uptrend. Any generalized market drop will likely see the ETF cushioned from the decline better than the specific stock(s).

Sell stock and buy calls or structured products – This can be done as a stock substitute to limit exposure, or risk. Inexperienced investors often associate options and structured products with leverage and increased risk, but this is not the case when applied properly. Instead, this is a great way to take the emotion out of portfolio management when wealth preservation is the order of the day. In the event the market turns and rises, which can easily happen, you’re still on the field and participating in the game.

Consider buying protective puts on individual equities as an insurance policy against declines – This allows you to insure your stocks while leaving the door open for upside gains should the market rise instead of declining. To determine what strike you buy, ask yourself how much you are willing to risk. For instance, let’s say that the stock you own is at $50 and you don’t mind holding the stock down to $45, but after $45 you want someone else to carry the risk. That would tell you that you would purchase a put struck at $45, and we suggest going out about three to six months in terms of time.

Tighten up stop-loss points – As mentioned above, those stocks that breakdown will hit your stop, and allow you to raise cash that can better be put to use elsewhere, such as in non-correlated assets like fixed income.

Trim positions that still have strong technical attributes but where you have sizable profits – In individual stocks, perhaps you take 30% off the table if the position is up by 30%, and take roughly another third off when the position is up 50%.

Watch for deterioration in technical attributes of stocks you own – It is very important to watch for any technical signs of stock breaking down below a support level, as this will indicate a change in relative strength and/or trend. As a general rule of thumb, stocks are considered technically sound if trading in an overall uptrend, i.e., making higher highs and higher lows.

Hold strong relative strength sectors, focusing on those that are favored – You can consult us to find out what sectors are currently in favor (or maybe which sectors are NOT in favor) to provide some guidance in your overall asset allocation. Below are some broad sectors ranked according to their relative strength currently. A good rule of thumb is to always be invested in those assets that are ranked higher than Cash (marked below with the ticker MNYMRKT).

, Basic Guidelines to Decrease Portfolio Risk

Investors should always keep up with changes on the relative strength front. You can always ask us to provide the above analysis and recommend alternative assets that are performing stronger on a relative basis. We would be happy to also discuss some of the other strategies outlined above.