The 2016 calendar year performance of the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) so far has been anything but stellar, with the index down around 2% excluding dividends.
While that wouldn't immediately suggest we are in the midst of a raging bull market, the market could be vulnerable to a correction. As I noted here, there are reasons to be nervous!
Whilst a major market correction may (or may not) be looming, there would appear to be signs that investors should at least consider being defensively positioned.
So what is the best way to position your portfolio so that it can survive a major market correction?
Once again, heeding the words of Warren Buffett can help:
"Rule # 1, don't lose money. Rule # 2, don't forget rule #1"
It's a catchy phrase but there is of course a deeper level of thinking to be applied. Consider what happens if a stock holding falls 20% from your purchase price…
If you're thinking you need the stock to bounce back 20% to return to break even, unfortunately your wrong. You actually need the stock to rise by 25%.
The situation gets even more acute the further a stock holding falls. A 33% fall will require a 50% gain, while a 50% drop requires a 100% gain to restore a stock back to your purchase price!
Realising the uphill battle which must be fought just to get back to a breakeven point makes it clear why Buffett aims to avoid losing money.
It's important to note however that Buffett is referring to real loses – the kind you experience when you make a bad purchase decision. He's not simply referring to quoted prices and advocating worrying about the ebbs and flows of share prices and the share market.
So what types of companies give your portfolio the best chance of survival?
Well, first and foremost they need to be of a reasonable quality with a sustainable business model and a solid balance sheet.
Companies such as Brambles Limited (ASX: BXB) and Amcor Limited (ASX: AMC) fit the bill.
Importantly though, they must also have been purchased at a reasonable price. Even a great company, if it is purchased far above fair value will leave your portfolio vulnerable to a severe correction.
