How Should a Worried Fool Hedge His Portfolio Today for a Bearish Tomorrow?

MarketsMotley Fool

In this Rule Breaker Investing podcast, David Gardner brought in some special guests to help him respond to his listeners' questions, and for this segment, it's Jeff Fischer, head of Motley Fool Pro and Options.

The question is, in essence, what should a Fool who's feeling the breath of the bear on the back of his neck do to prepare? And though we consider market timing a bad way to go, Fischer is the Fool who thinks most about hedging your bets, and he talks about how he does it in Motley Fool Pro.

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A full transcript follows the video.

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This video was recorded on Feb. 28, 2018.

David Gardner: This one comes from @TeddyBeingTeddy, who sometimes writes into this podcast. "@RBIPodcast. If, hypothetically, you thought there was going to be a big drop in the stock market this year, what specifically would you invest in to hedge that risk? Vanguard bond funds, real estate, cash, utilities, war stocks, other? Help us preppers prep for a cold winter!" I think that all fits in one tweet.

I have a quick initial response I'm going to give, but I really wanted to have Jeff in, because he thinks about these things. My quick, initial response is I don't spend a lot of time thinking about that myself. That's why in some ways, I can be very helpful to some listeners of this podcast, because they're also in it for the long haul. I know you are, too, Jeff. So, I expect market drops. I don't worry about them. I'm not changing up my allocation in reaction to that.

However, there are also a lot of people listening to this podcast, and other Motley Fool podcasts, for whom a big drop could hurt if they're retiring this year, or they're near the end of their life and they're living off of the capital that they're invested in. I don't necessarily want you just to speak to that mentality, Jeff, but how do you think about that? Because you're somebody who is our expert here at The Motley Fool thinking about hedging in some cases. Or doing well even in flat markets. What's your take on Teddy's question?

Jeff Fischer: A great question, and so many of us have that question. Like you, David, I don't try to guess where the market will go, but the ideal is to have a portfolio that you are comfortable with if the market does fall. In essence, you're always prepared for the market to fall.

And for everybody that's different. For some people near retirement, that means that they maybe do have a 60%-40% portfolio. 60% stock, 40% fixed income. But for those who have 100% stock and are worried about the market, they may learn to slowly increase their cash balance and carry one, typically, which I typically do as well. It ranges anywhere from 10%-25% cash at any given time. And I can get a lot of flak for that, because that money isn't invested and isn't earning returns, and will even lose to inflation.

Gardner: Did you mean you get a lot flak for that, or did you mean Slack, one of our advertisers and the regular app that we all use? You could get some Slack for that too, Jeff.

Fischer: I do mean flak, and it's also Slack in the portfolio. But that cash makes me feel comfortable with what I own, and when opportunities come along either in individual companies that I'm following, or the market as a whole declines, you have some cash to put to work.

So, in regard to the question. Do I buy real estate? Do I buy war stocks? Do I buy bonds? I would say no to all of those. Defense stocks -- you don't know if they'll do well when the market falls. Real estate -- the same thing. Bonds, right now, are not doing well as interest rates go up, so unless you hold them to maturity, you're looking at a loss. Even in your bonds, bonds have gotten clocked lately.

Of that list, I would say cash is the best hedge you can have. It's something you know will be there ready for you when you're ready to invest it. It gives you peace of mind. It will dampen the volatility in your portfolio. And it's available to use in life, as well, if you need it. So, it's a really simple way to hedge to raise some cash, selling things you don't like. Selling losers that you no longer want to own and raise some cash for a proverbial rainy day.

Gardner: Awesome. And that's something that you've done in Motley Fool Pro.

Fischer: Motley Fool Pro we've held, on average -- I should look it up -- but on average 15%-20% cash for many years, and yet we've outperformed the S&P despite that.

Gardner: Which is awesome, and I'm sure confounds a lot of experts which would think that's not even possible.

Fischer: So, if you're buying Foolish-type companies, David, as you know, like a Visa or in your case an Amazon or Netflix, those just crush the market over time, and that allows you to outperform the market even if you carry some cash for defense.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. David Gardner owns shares of Amazon and Netflix. Jeff Fischer owns shares of Amazon, Netflix, and Visa. The Motley Fool owns shares of and recommends Amazon, Netflix, and Visa. The Motley Fool has a disclosure policy.