By John Wasik
CHICAGO Nov 26 Nervous Nellies can't stand
losing money, so they typically hedge their portfolios with
investments seeking to preserve capital. With the fiscal cliff
looming, there are a lot more of these worriers out there who
are (temporarily) looking to put together worst-case scenario
Whether you think that the fiscal cliff crisis won't be
resolved by the end of the year or fear inflation, a
calamity-proof portfolio can hedge against any number of perils.
This would be a prudent approach for anyone primarily focused on
capital preservation or a subset -- possibly 40 percent -- of a
larger portfolio in which you need to temper stock-market risk.
You can create it yourself or buy it off the shelf in the form
of a mutual fund.
When looking to safeguard your money, keep in mind that this
is not an aggressive or moderate growth portfolio. If you're
young, can afford to take some risk or have a solid guaranteed
pension waiting for you, this is not an ideal strategy for you.
One way to go is the iShares Barclays 7-10 Year Treasury
bond fund ETF, which has returned almost 8.5 percent
during the last five tumultuous years through Oct. 30. It's up
3.6 percent year to date. While this fund has some interest rate
risk -- its value will decline if rates climb -- there's
negligible credit risk if the U.S. pays back its creditors.
Because they fear the worst in terms of the dollar's further
decline and seek safe havens from global turmoil, conservative
investors also favor gold, best purchased through the SPDR Gold
Trust, which holds bullion in a vault in London. The
fund's price is linked to the over-the-counter market for the
pale metal. In the event of the U.S. government falling over the
fiscal cliff -- triggering some $600 billion in taxes and
possibly a recession -- gold would be somewhat of a refuge.
Another calamity hedge against U.S. stocks are inverse
exchange-traded funds linked to U.S. stock indexes. When stocks
fall, they rise in value. Say you wanted some protection against
a decline in the largest U.S. stocks in the S&P 500 index. A
fund like the ProShares Short S&P 500 ETF is a
consideration. If you wanted twice the inverse movement of the
index, then a leveraged ETF such as the ProShares Ultrashort S&P
500 would be a choice.
With inverse ETFs, though, you need to heed a whole set of
risk factors. They will lose money if the market rises and they
don't always track market indexes precisely. It's unwise to make
an "all-in" bet on these risky ETFs.
What if you wanted to hold a small position in stocks that
you will keep long after the fiscal storm blows over? Consider
the Vanguard Health Care Index fund, which has
relatively low volatility and holds durable, mature companies
like Johnson & Johnson and Merck. S&P Capital
IQ, a financial services data provider, is currently
recommending an "overweight" position for the fund. Healthcare
stocks offer a modest defensive position for investors who are
concerned about short-term volatility.
If you wanted to create a weather-the-storm kind of
portfolio with the above funds, I would suggest 60 percent in
the bond fund, 20 percent in gold, 10 percent in the inverse
stock fund and 10 percent in the healthcare ETF.
One of the best ways to find most of what I've recommended
above in one package -- and then some -- is through the
Permanent Portfolio. This low-risk portfolio has long
been a favorite of nervous nellies.
Designed for inflation-obsessed investors, it features a 35
percent stake in U.S. Treasury bonds, 25 percent in gold and
silver; 10 percent in Swiss Franc assets; 15 percent in U.S.,
foreign real estate and natural resources and 15 percent in
aggressive growth stocks.
More than half of the portfolio is geared to protect you
against dollar devaluation and stock declines and a commodity
inflation hedge through real estate and natural resources
stocks. It's largely constructed to "preserve and increase the
purchasing power of each shareholder's account over the long
While the Permanent Portfolio has proven it can hold up well
in the worst markets -- it only lost 8.4 percent in 2008 -- it
will underperform a growth-oriented approach that will benefit
from broad-based economic prosperity. It simply won't capture
the gains of a diversified stock fund such as the Schwab S&P 500
Index fund. Over the past year, the Schwab fund is up
15 percent through Oct. 31 versus 6.4 percent for the Permanent
The biggest downside with a conservative strategy is
opportunity risk. If the fiscal cliff comes and goes without a
huge sell-off or if inflation remains tame, you will be missing
out on a stock rebound that's been in progress with fits and
starts for more than three years. That's why it makes sense to
pick and choose among the portfolio risks you most need to hedge
against. Preserving capital and keeping inflation at bay always
seem to be perennial concerns.
Yet if you're looking for capital preservation with
volatility that's often half that of the S&P 500, the Permanent
Portfolio or my suggestions above can get you through major
crises with minimal bruising.