Over the last month, search volumes for terms like ‘protect my investment’ and ‘protect investment portfolio’ have soared. It’s not hard to see why – there’s a lot of economic uncertainty right now and stocks are exhibiting high levels of volatility.
Want to try to build a bullet-proof Stocks and Shares ISA to mitigate risk and aim for more stable long-term growth? Here are some risk management strategies to consider.
Reducing risk
Risk can never be eliminated entirely from an investment portfolio. Unless you’re 100% invested in cash (which has its own risks due to inflation), you have to accept some portfolio volatility.
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However, with a few simple strategies, it’s possible to reduce risk significantly. One such strategy is spreading your capital out over many different investments (diversifying your portfolio).
Diversification 101
Now, to diversify properly, you need to do two key things. First, you need to diversify by asset class. This means owning a range of different assets including stocks, bonds, commodities (eg gold), and alternative investments (eg commercial property). The idea here is that if one asset class falls, another may provide some protection. A good example is gold, which is viewed as a safe-haven asset. While stocks have fallen this year, gold prices have risen.
Next, you need to diversify within the asset classes. In other words, you need to aim to own different types of stocks, bonds, commodities, and so on. This can give you much more protection. For example, owning 50 stocks is far safer than owning five.
Diversifying stocks
When it comes to diversifying your stock portfolio, it’s smart to own stocks from different industries. You don’t want to be 100% invested in tech stocks, for example.
It’s also smart to own a range of different types of stocks. Some examples here include UK, international, large-cap, small-cap, dividend, and growth stocks. ‘Defensive’ stocks can also play a key role in protecting portfolios. These are stocks in less economically sensitive areas of the market such as food/drink and utilities.
It’s worth pointing out that if you’re investing in individual stocks, it’s a good idea to give some thought to position sizing. Generally speaking, it’s sensible to give large-cap, blue-chip stocks larger weightings in your portfolio than speculative small-cap stocks. This is because large-cap stocks tend to be less volatile than small-cap shares.
Focusing on quality
It can also pay to focus on high-quality companies (those with stable earnings and strong balance sheets). These tend to be more resilient than others and their stocks often outperform during economic weakness.
One ETF that focuses on high-quality companies – and could be worth considering today – is the iShares Edge MSCI World Quality Factor UCITS ETF (LSE: IWQU). This offers exposure to about 300 companies that screen up as high in quality (including the likes of Apple, Microsoft, and Visa).
This ETF’s certainly helped to protect investors’ portfolios recently. Over the last month, its value has fallen far less than the broader market.
It’s worth pointing out that this ETF isn’t going to outperform all the time. There will be times in the economic cycle when low-quality stocks (eg unprofitable companies) surge and quality stocks lag the market.
I think it’s wise to incorporate high-quality companies into a portfolio and I see this ETF – which has an ongoing fee of just 0.25% – as a solid choice to consider.
