Are you protecting the downside risk to your portfolio?

US stock markets continue to go from strength to strength amid signs that controversy surrounding Donald Trump is being ignored. Time will tell but many experts are now of the opinion that valuations are being stretched and there could be a short-term correction and consolidation at lower levels. So, are you protecting the downside risk to your portfolio or do you believe there is further upside?

Insurance policy

There are various insurance policies you can look at to protect your portfolio from any short-term correction in stock markets. They include:-

Traded options

It is possible to buy options in individual indexes and individual shares which give you the option (but not the obligation) to sell a particular asset at a predetermined price over a predetermined period. Effectively these allow you to introduce an insurance policy which will partly offset any losses if the markets or a particular stock fell sharply. The fact that volatility on the US markets is at an all-time low should also help those looking at traded options because the implied volatility risk in these options will also be at its lowest.

Are you protecting the downside risk to your portfolio?
Are you protecting the downside risk to your portfolio?

Gold

For many years now gold has been seen as a safe haven in times of trouble and as the US stock market continues to move higher many individuals and professional investors have been increasing their gold exposure. The idea, like traded options, is that a flight to safety in the event of a sharp downturn in the US market would push the gold price higher and at least partly offset the loss in portfolio value. It will obviously depend upon which companies you are invested but the idea is to use gold as a hedge against downside in the short to medium term.

Taking the brave option

The use of traded options and gold negates the transaction costs associated with selling shares so there is potentially small savings there. However, if you are looking at traded options and gold to protect your portfolio, why not just sell-up?

There are very few investors who are brave enough to go fully in cash as a means of protecting their portfolio values. The problem is that nobody really knows how markets will react in the short to medium term and therefore selling up today may see investor miss out on further upside. It is fear and greed, the fear of selling too early and greed, simply not wanting to give away money. However, if you have made a significant return on your investments in the short to medium term is it really wrong to take a profit?

Protecting your portfolio from any downside

Whether you look at traded options, gold or selling up, if you are concerned about the relatively high valuation of either the stock market or individual shares there is no point burying your head in the sand. If you have a good profit then is it really wrong to crystallise this? The day when it is wrong to take a profit on any stock is the day when hell freezes over because at the end of the day that is why we invest, surely?

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