If you want to reduce your portfolio risk, you need to balance volatility. It is the key to reducing risk, building wealth, and sleeping well at night.
As it relates to trading, balance can be difficult to follow through on. Most traders and investors choose to play the bullish side at all times because, well … that is the long term trend of the stock market. Any drops in the markets over the last 100 years have been easily absorbed. Even the crash of 1987 is a blip on the screen of the monthly SPX 500 chart.
So why would an investor or trader need to be worried about having downside protection? To fend off the frequent volatile action that comes from emotional impulses.
3 ways to reduce portfolio risk
First, spread out your portfolio risk by diversification. Have you heard the saying, “Diversification is the only free lunch you’ll get”? It’s true.
Add names to your portfolio that are sure things, risky, and not-so-risky. It will ultimately reduce volatility and the big swings that happen during uncertain times.
Second, spread out your capital along different asset classes, especially ones that have little correlation. A low correlation portfolio means your positions will not necessarily move in the same direction.
Let’s say your portfolio has a mix of:
- US equities
- European equities
- Fixed income (bonds)
- Real estate
- Gold and/or silver
- Bitcoin
- Cash
This is an ideal spread balance of portfolio risk that eliminates the sting of market volatility. (Harry Markowitz first developed the concept of a diversified portfolio as the most efficient back in 1952, and it has stood the test of time.)
Finally, options trading. There is no better way to blunt rising volatility than protecting your holdings with put options.
I have been preaching this to the choir for years, and those who listened have saved themselves from pain. You may believe puts are a waste of money but when volatility picks up (often unannounced), you’ll be glad the puts are there to cover your downside.
If options trading is new to you, start your journey by taking my free mini course: Spread Trader Fundamentals.
