Volatile markets bring investors many challenges. One of the biggest concerns is how to manage money well in the midst of uncertainty. However, three basic moves make that worry a bit easier to tackle.
1. Have some cash on hand (“Cash is king”)
Cash serves as a buffer against losses as well as allowing one to buy great companies at lower prices. Investors should also make sure to harvest losses. If money is already lost and the prospects of a company in one’s portfolio have fundamentally changed, then selling creates a capital loss deduction against taxes. This frees up funds to buy other companies that may do better in a volatile market.
Investors can seek assets that pay cash, such as dividends, for instance. Again, dividends provide some downside protection if volatility’s growl starts to sound like a bear. For example, a 5% dividend yield is also a 5% cushion against losses. Note that the dividend yield increases when stock prices fall.
One backdoor way of having a portfolio rich in cash is to invest in companies that themselves have high cash balances on their balance sheet. Businesses with cash are also able to cushion the blows from a weakening economy. Cash-rich companies are able to acquire other businesses at lower cost to capital or can use the money to invest in innovation to outpace their competition.
2. Pay attention to industry fundamentals
One harbinger of a recession is to pay attention to the weakest company in an industry. If weak firms begin to struggle, then it is usually an early warning sign that the entire industry is under pressure from a weakening economy.
3. Buy companies that focus on return on invested capital (ROIC)
Return on invested capital is one way to manage a business. If company management is constantly focused on managing capital for the highest return then downturns are likely advantageous for them relative to competitors. Once the economy strengthens their performance relative to peers is likely to accelerate.
Doing all three of these things will leave investors better poised in a shaky market compared to those who don’t. And it will allow investors a chance to take advantage of the volatility rather than becomes its victim.
--Jason Voss, CFA, CFA Institute
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