How And When To Get Defensive

What the heck does investing defensively mean? Why and when should we invest in such a manner?

Ah, these questions are very common and often addressed on such silly shows that appear on MSN, however, they are rarely ever explained in a manner that the average investor can understand. They merely spit out terms such as cyclical and business cycle to describe stocks. They probably use this, because they themselves have no f’ing idea what they are talking about.

Anyway, what does investing defensively mean? In the most basic terms, it means investing in companies that do well or are consistent during economic booms and busts. Basically, they produce goods and services that are needed regardless of the state of economy and market (a.k.a. non-discretionary items). Some of the best defensive companies actually perform better when economic conditions are poor.

Why should you invest defensively? The main reason for having your portfolio contain some defensive stocks is so you have a hedge for when the market takes a big dive. This will mitigate your portfolio from having a large drop and taper your paper losses. It also helps balance your portfolio.

When should you invest defensively? This question has a not so simple answer. It all depends on the person and their investment goals. If you are the type that doesn’t like a lot of risk, then your portfolio should contain mostly a diverse number of defensive stocks with a mix of bonds, cash and other equities. If you like a lot of risk, then you should probably only invest defensively, when you think the market is ready for a large drop (at least 10%). Then you would trade out your bull market stocks for defensive stocks. If you just the average investor willing to take a little risk, but not a lot of risk, then you should always carry some defensive companies in your portfolio. If you think the market is overvalued and due for a correction, then you would want to increase your defensive holdings to reduce your losses in the event of a large drop. If you think the market is undervalued, then you should look to lighten up on your defensive holdings and snap up stocks with bigger potential upside.

To further illustrate what defensive stocks are, I’ll list some examples and why they are considered defensive stocks.

Johnson & Johnson (JNJ)- huge product line from shampoo to over the counter medicine. Nearly all of their products will continue to be purchased during poor economic times.

Proctor & Gamble (PG)- basically, the same reason as JNJ, but their product lines deal heavily in beauty and health care. However, they also have food and coffee brands.

McDonald’s (MCD)- does well in any economy, but does extra well in poor economies, since people will sacrifice the health for cheap food.

Reynold American, Inc. (RAI)- one word, “Tobacco”!