Though they sound similar, Defensive Investing and Defensive Trading are not the same thing. They are both risk management approaches which serve to ‘defend’ one’s capital and one’s gains at all costs.
The key difference is that Defensive Trading can be applied to any asset in the Financial Market, and is a long-term and safety-first approach based in the concept of trade quality over trade quantity.
Defensive Investing, however, is a portfolio allocation method and management designed to minimize the risk of losing capital. Let’s explore Defensive Investing more.
What is a Defensive Investing Strategy?
The defensive investing strategy is a conservative portfolio allocation method and management designed to minimize the risk of losing capital. A defensive investing strategy involves regular portfolio rebalancing to maintain intended asset allocation; buy high-quality short-term bonds and first-class stocks; diversifying in both sectors and countries; placing stop-loss orders; and holding cash and cash equivalents in declining markets. These strategies are intended to protect investors against significant losses from significant market downturns.
Understanding A Defensive Investment Strategy
Defensive investment fund strategies are designed to offer protection first and modest growth second. In contrast, with an offensive or aggressive investment strategy, an investor tries to take advantage of a rising market by buying stocks with a higher yield for specific risk and volatility levels. An offensive process can also involve the Choice of trade and trade margins. Offensive and defensive investment strategies require active management. to have higher investment fees and tax obligations than a passively managed portfolio. A balanced investment strategy combines elements of defensive and offensive strategy.
Defensive Investment Strategy and Portfolio Management
The defensive investment strategy is one of several options in portfolio management practices. Portfolio management is art and science; Portfolio managers must make important decisions by themselves or their customers, considering the specific investment objectives and choosing appropriate asset allocations, balancing risks and potential.
Many portfolio administrators adopt defensive investment strategies for risk-averse clients, such as retirees without constant salaries. Defensive investment strategies may also be appropriate for those who do not have Much capital to lose. In both cases, the objectives are to protect. the existing capital and maintain inflation through modest growth.
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What Investments Should I Use For A Defensive Investment Strategy?
Selecting investments in high-quality bonds, mature US Treasuries (T-Notes), and top-tier stocks are sound tactics for a defensive investment strategy. Even when choosing stocks, a defensive portfolio manager will stick with big, established names with good records, that portfolio manager is more likely than support exchange-traded funds that mimic market indices, as they offer exposure to all established stocks in a diversified investment.
A portfolio manager who practices a defensive strategy may also have a trench of cash and cash equivalents, such as T-bills and commercial paper can also help keep pace with inflation and protect the portfolio in markets down. However, holding too much cash and cash equivalents can raise questions about why investors are paying for active management in the first place.
First, it must be clear that the defensive investment objective is to obtain the average return of the market since it is tough to exceed it consistently. It is interesting to note that many equity funds with professional managers fail to obtain the average market return. It’s also worth noting that getting a return on the market doesn’t necessarily mean you’ll make a profit.
This classic text is annotated to update Graham’s timeless wisdom for today’s market conditions…
The greatest investment advisor of the twentieth century, Benjamin Graham, taught and inspired people worldwide. Graham’s philosophy of “value investing” — which shields investors from substantial error and teaches them to develop long-term strategies — has made The Intelligent Investor the stock market bible ever since its original publication in 1949.
Over the years, market developments have proven the wisdom of Graham’s strategies. While preserving the integrity of Graham’s original text, this revised edition includes updated commentary by noted financial journalist Jason Zweig, whose perspective incorporates the realities of today’s market, draws parallels between Graham’s examples and today’s financial headlines, and gives readers a more thorough understanding of how to apply Graham’s principles.
Vital and indispensable, this HarperBusiness Essentials edition of The Intelligent Investor is the most important book you will ever read on how to reach your financial goals.
Thus, the strategy that the defensive investor must use is quite simple. It is enough that your portfolio reflects the composition of a broad market index, such as the Bovespa Index – which is, by definition, the market. In this way, the ideal strategy for the defensive investor would be to buy all the index shares, as this gives you the guarantee that you will always obtain the average return on the market. Since doing this is unfeasible for most investors, Graham suggests selecting individual stocks, which we will see in the next topic.
However, today there is an easier and more accessible way to return on a market index. With the advent of the digital age, financial institutions. We have created increasingly sophisticated investment products, such as so-called “index funds” or “ETFs.”
Index funds are nothing more than mutual funds traded directly on the stock market that accompany a specific market index. They are managed passively, simply reflecting all the actions that make up a particular index to obtain the same performance. Thus, instead of buying all the stocks that are part of the Bovespa Index, it only purchases an index fund that accompanies that specific index.
Index funds are an investment in which it is improbable that you will have any suffering or surprises, even if you doze off for twenty years. They are the realization of the defensive investor’s dream. After building a portfolio permanently on autopilot and based on index funds, you will be able to answer every market question with the most potent answer a defensive investor can have: “I don’t know, and I don’t want to know.” The recognition that you know very little about the future is undoubtedly the most potent weapon of a defensive investor. Can learn more about index funds by looking at the article How to Invest in Stocks with Index Funds.
Once all you need to do is buy index funds, using the medium cost strategy, there is no need to search and select your stocks. In reality, for the vast majority of people, this is not even advisable. However, some people like the idea – of the fun and intellectual challenge associated with it – of choosing individual actions.
If this is the case for you, I recommend that instead of building a complete portfolio of stocks, you use an index fund as your foundation. Always remember that the goal of defensive investing is to get the average return on the market. While index funds are a guaranteed option for such a return, there is no guarantee of that return in the case of individual stock choices.
So I suggest you keep about 90% of your equity money in a broad market index fund, leaving the remaining 10% to try and pick stocks on your own. In the next topic, we will see how Graham suggests that the selection of individual actions should be made.
Graham proposed a relatively simple investment strategy for the defensive investor that only requires a little research. To select individual stocks that make up the diversified equity portfolio, Graham suggests seven quality and quantity criteria, listed below.
- Adequate size of the company: To avoid small companies that may be subject to adversities above normal, Graham suggests investing in companies not less than US $ 100 million of annual turnover in the case of an industrial company, and not less than the US $ 500 million in total assets, in the case of a utility concessionaire.
- A sufficiently strong financial condition: In industrial companies, current assets should be at least twice current liabilities (or a current liquidity ratio greater than 2). In the same way, long-term indebtedness (non-current liabilities) should not exceed working capital / current net worth. In public service concessionaires, the debt should not exceed twice the capital stock, valued at book value.
- Profit stability: Uninterrupted profit (without any loss) in the last ten years.
- Dividend history: Some dividend payments for each of the last twenty years.
- Earnings growth: Minimum 1/3 increase in earnings per share in the last ten years, using three-year averages at the beginning and end.
- Average price/earnings ratio: The P / L ratio should be less than 15 for the last three years’ average earnings.
- Average price/asset ratio: The P / VPA ratio should be less than 1.5. However, a higher P / APV can be accepted as long as the P / L (Price / Earnings) multiplied by the P / APV (Price / Value per share) does not exceed 22.5.
These seven criteria exclude all too small companies in relatively weak financial conditions, have the stigma of a loss or do not have a long and uninterrupted history of paying dividends. On the other hand, it will include companies with an excess of tangible assets, few debts, and traded at a significant discount concerning their price to have little probability of falling.
The Problem With Defensive Investing
Searching for stocks that meet the established criteria is a necessary but not sufficient condition to select good stocks for the portfolio. In addition to applying the above criteria for selection, the defensive investor should read the annual and quarterly reports for each company, reading at least the last five years’ accounts. If you are not willing to present minimal reading and making basic five-year financial health comparisons, you are too defensive to buy any single stock. You should get out of the stock choice business and apply only to index funds.
How Realistic Is This Approach To Investing?
Graham’s criteria for selecting individual stocks were presented here and appear in his book The Smart Investor. If you are looking for stocks that meet these criteria on the stock market today, they likely feel disappointed to find that stores like these don’t exist. If you are interested in stock selection, I recommend you see this other article that I wrote in analyzing the viability of Graham’s strategy using similar criteria applied to the Brazilian stock market.
The Final Word On Defensive Investing
Graham presented an almost mechanical investment method for the defensive investor: just buy quality stocks and diversified stocks in equal proportions and at equal intervals of time. And it has never been easier to build a defensive investment portfolio than today when you can use instruments like index funds instead of selecting individual stocks.
Thus, the defensive investor can obtain the market’s average profitability without spending a second even following the market or making constant modifications in his investment portfolio. The investor will not have any headaches with their investment portfolio; all they will have to do is set and forget – ride and forget it.
As always, if you have any questions, we would love to hear from you in the comments box below. Happy trading!
