The Basics of a Defensive Investment Strategy

As market volatility and recession fears mount, many investors are looking for ways to minimize risk in their portfolios. One common way to do so is through defensive investments.

Defensive investing is a strategy that can help investors weather stormy markets by forgoing higher returns in exchange for more asset protection. A common tactic entails building a portfolio around lower-risk assets — cash, bonds, guaranteed investment certificates (GICs) and stocks in defensive sectors come to mind — then rebalancing the mix if needed to keep it within your risk tolerance.

While the idea of striving for stability through difficult times can sound great to investors of all stripes, this investment style comes with pros and cons:

• Potential Benefits: Capital preservation, guaranteed investments and certainty on your returns can equal peace of mind.
• Potential Risks: Low returns may mean you're not keeping up with inflation. Stronger investment growth may be needed depending on long-term goals. Less risk doesn't mean risk-free — your investments can still lose value.

What else should you know to help determine if defensive investing is the right fit for you and your portfolio? Read on.

Minimizing risk

A smartly crafted portfolio can help you manage risk and decrease the impact of market volatility, ultimately helping you safeguard profits. Start by identifying your investment style and asking yourself some important questions about risk. Then:

Understand the relationship between assets and risk. For example, someone with a higher risk tolerance or a longer investment timeline may hold a higher percentage of equities; someone with a lower tolerance may lean toward bonds and other defensive assets (more on that later!).

Consider diversifying your investments. Diversification across asset classes and investment types can be a lot like pleasing a dinner crowd: an array of dishes (or investments!) can help increase the likelihood of meeting your goals. Exchange-traded funds (ETF) and mutual funds are designed for instant diversification, and may offer exposure to many asset classes in one.

Ask: Is your portfolio overweight? Over time, your asset allocation can drift from your original plan, exposing you to unwanted risk. Regularly rebalancing your portfolio can help you stay within your parameters.

Selecting defensive assets

Self-directed investors often hold a percentage in so-called defensive assets – think cash or fixed-income products like bonds and GICs. While there's no such thing as a risk-free investment (even cash and GICs aren't immune to inflation), defensive assets tend to carry lower levels of risk, but may offer less reward. Here are some you should know about:

Cash. Remember, when equity markets go up or down: cash is still cash. It generally holds its value, but that can be both its strength and its weakness.

GICs are a secure investment as most are 100-per-cent guaranteed (principal plus interest) by the CDIC up to $100,000. Learn more about how they're protected at CDIC.ca.

Bonds can be used to generate a predictable stream of interest income and/or promise a future lump-sum payment.

Defensive equities can also make for a smoother ride. While no stock is immune to an economic slump, non-cyclical sectors, or defensive sectors, tend to fare better during rough times due to their stable earnings (utilities, consumer staples, health care and so on). Mature businesses that pay steady dividends¹ can also fall into this category.

Before adding any new assets to your mix, take a moment to consider the tax impacts of your choices. For example, the return you generate from GICs and bonds is taxed differently from capital gains or dividends yielded by equities, and can be taxed as income.

Researching for the long term

Thorough research can help you feel confident that a company has what it takes to stick around until your goals are achieved – or at least recover after a period of volatility. Likewise, it can give you the tools you need to craft an exit plan.

Look for opportunities. Wondering where to get started with your research? Take a look at our research guide.

Crunch the numbers. Don't just go with your gut. Fundamental analysis is one tool investors can use to determine the true value of a security – here's how it applies to the value of stocks and ETFs. You can also try technical analysis.

Put it all together. No one research technique will give you all the answers. Knowing a few smart research basics and visiting multiple sources can help you go further with your research.