Market sell-offs are indeed some of the most frightful situations in the Financial Markets. It is why protecting your portfolio from unnecessary and potentially massive losses that could result from this must always be your top priority, especially when the market is not going according to your will.

Techniques to Protect your Portfolio

There are numerous ways you could protect your portfolio. However, they all have a crucial commonality: Risk Management tools that aim to minimize risk and the corresponding potential losses that could result from the inherent investment risk. Below are the three of the most effective techniques to accomplish this.

Hedging

It is one of the most technical and sophisticated techniques. Hedging, in simplest terms, is a risk management strategy used to offset losses in an investment portfolio by taking an opposite position in an affiliated asset class. Furthermore, Hedging requires the investor to pay a legal tender (usually money or the security itself) for the protection it provides; this is known as the “premium” for this risk management tool. Professional hedging strategies usually include derivatives, such as futures and options contracts to accomplish this goal. 

Hedging occurs almost everywhere. For example, if you purchase a house and get yourself a homeowner’s insurance, you are hedging against unforeseen disasters, such as fires, earthquakes, typhoons, and even break-ins. Hedging against investment risk is done by strategically using financial securities or instruments to offset the risk of a significant price movement going against your bias. If this concept is something new to you, you must consult an expert on this to properly guide you and show different hedging strategies that best suit you as an individual and your goals, rather than risking it by experimenting on your own.

Asset Allocation Rebalancing

The theory of Asset Allocation systematically puts a maximum percentage allocation you could invest in a particular asset class or investment security. For example, if your original portfolio before the market sell-off invests 70 percent of your total funds in equities (preferred or common stocks), 20 percent in government securities (bills, government-issued bonds, etc.), and 10 percent in Money Market instruments or low-risk bank investment products. With this model one may be rebalancing it to 50 percent of your total funds in equities, 30 percent in government securities, and 20 percent in money market securities/ low-risk bank investment products during the market sell-off.

Portfolio Diversification

Last but not least, after you determine your asset allocation strategy, you could now proceed to “diversify” by buying more than one holding per asset class. For example, if you plan to buy three blue-chip stocks, you could buy each of the three stocks in different sectors, one could be in the technology sector, another in manufacturing, and the last could be in the banking sector. Diversification ensures that you are optimizing your risk management in an asset class. You could consider reducing your current holdings in these sectors and buying in an industry that is least affected or even has benefited from the recent market sell-off.

Incorporating one or more of these risk management tools may help you stay true to your personal investment goal while at the same time protecting your portfolio from the potential massive swing of losses brought by more than an optimized level of risk exposure, especially during a market sell-off period.

Please note that this is not financial advice, and anything mentioned in this article is for educational purposes. Always consult with a financial advisor before making any investment decisions.