The Motley Fool

How to protect your share portfolio from volatility

The S&P/ASX 200 (index: ^AXJO) (ASX: XJO) has had a pretty wild week so far – not much different to the past few months though.

As you can see from the chart below, we’ve had 2 major market falls of more than 3.8%, while the best gains we could make were two days over 2%.

ASX 200 daily performance

Source: Standard & Poor’s

Of the 67 business days since July 1, more than half (34 days) have been moves of more than 1% (either up or down). In the 67 trading days before that, there were just 18 days where the market moved by more than 1% (again up or down).

Since the highs of April 2015, the S&P/ASX 200 has also dropped 14% and likely made a mess of many investors’ portfolios, including mine.

The big question many investors face is, “How do I protect my portfolio during these periods of volatility?

What you shouldn’t do

  1. Sell everything and move to cash. Trying to time the market is a fool’s (lower case ‘f’) game. By the time you pluck up the courage to buy back in, most of the gains are likely to have been made. How do you know when to buy back in? After the market has jumped 2%?
  2. Sell out and switch to other stocks. Again, trying to pick the bottom is likely to fail. If you don’t have your portfolio well set up before the volatility, trying to fix it during periods of big market moves is likely to hurt your returns.
  3. Check your portfolio every day or every hour. Chances are, you might do something silly. Best to ignore the moves and check it less frequently.

What you should do

  1. Make sure your portfolio is well diversified before the volatility. Ok, that’s easier said that done, but it does pay to have a number of defensive stocks (i.e. those that offer products and services that consumers and/or businesses need every day) such as Telstra Corporation Ltd (ASX: TLS), Woolworths Limited (ASX: WOW), Wesfarmers Ltd (ASX: WES) and CSL Limited (ASX: CSL). All four companies have fallen less than the market, with CSL down just 5.7% since late April.
  2. A decent holding of cash on the sidelines to pick up bargains gives you optionality and you aren’t forced to sell stocks to buy others.
  3. Holding other assets, such as fixed-income ETFs, international ETFs, international stocks will all help to smooth out the volatility.
  4. A good helping of high-dividend stocks can help, with incoming dividends boosting your cash holdings allowing you to ignore the short-term fluctuations.
  5. Hold tight. Markets will resume their normal service at some point, as they have done after every ‘crisis’.
  6. Look for bargains. Volatility is the friend of the long-term investor and the enemy of the short-term trader. The best time to buy stocks in the past decade was in March 2009 – at the depths of the GFC.
  7. Focus on the long-term. In 5-10 years’ time, the market is almost certain to be higher than it is today. If you hold quality stocks, so will they.
  8. Get used to it. Markets fall – it happens. If you have the patience to ride it out, your portfolio will thank you.

Foolish takeaway

If you can’t handle the volatility and you are losing sleep over your falling portfolio, maybe direct investing is not your thing. That’s fine. Not everyone is cut out to manage his or her own investments, and you might want to consider putting your cash into a low-cost managed fund with a diversified range of investment asset classes. For those of you still happy to invest directly, patience is your greatest weapon against volatility.

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Motley Fool contributor Mike King owns shares in Woolworths, Telstra Corporation and CSL Limited. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.