How to Protect Your Portfolio from Volatility
If there’s one thing investors hate, it’s volatility.
After seeing global markets head higher and higher for the past decade, it’s hard to see markets fall by 5, 10, or 15 percent (like we did in February).
But corrections are normal.
And the fact is, sooner or later the good times have to end.
Mean reversion, as I’ve talked about before, means that markets (along with pretty much anything else in life) tend over time to reverse extreme movements – and gravitate back to average.
It’s like a rubber band… stretch it and when you let go it returns to its original shape. So after a period of rising prices, securities tend to deliver average or poor returns. Likewise, market prices that decline too far, too fast, tend to rebound. That’s mean reversion, and it works over short and long periods.
We’ve been saying for a while that markets around the world are “stretched” and could snap back to their “original shape” at any moment.
That means now is the time to prepare for whatever might happen… whether it’s another market correction, a crisis, a currency collapse, or something far worse.
So here are five things you can go right now to prepare for future market volatility.
1. Get your portfolio out of the house
For many people, there’s no place like home. It’s familiar and comfortable. But keeping your portfolio in your home country can be risky.
The idea behind diversification is simple. It means putting your eggs in different baskets. That is, spreading your risk across different types of assets, so that a decline in value in any one holding isn’t so bad – because there will likely be other holdings that rise to help balance out the losses. And geographical diversification is important, as we showed here.
Spreading a portfolio around the world reduces risk. After all, gains in one market can offset losses in another.
And while the gains in some markets are nearing an end, they’re just getting started in markets like India, Bangladesh and Vietnam. These are three of the fastest-growing markets in the world.
So do yourself a favour and diversify your portfolio.
2. Invest in alternative assets
It’s important to diversify your portfolio – not just outside your home country or in different types of companies – but through different assets. One way to do that is by owning commodities.
You see, many commodities are negatively correlated to stock markets.
Correlation is the relationship between two or more assets. When assets are negatively correlated, their prices tend to move in opposite directions. When they’re positively correlated, their prices tend to move in the same direction.
Take gold, for example.
History has proven time and again that gold is one of the best ways to hedge your portfolio – that is, to protect it when stock markets everywhere fall. That’s because gold and stock markets are negatively correlated assets. That means when equity markets go down, gold usually goes up – and when gold goes down, equity markets tend to go higher.
That’s why gold has outperformed through countless crises and “black swan” events throughout history.
Related: 10 Ways to to Avoid Information Overload
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