How to Protect Your Portfolio During a Downturn

Markets rarely fall in a straight line, but when downturns hit, they often strike faster than investors expect. In March 2020, global equities lost more than 30% in just weeks as the COVID-19 crisis spread, leaving unprepared portfolios deeply exposed. Preparation matters more than prediction: the right mix of assets, guided by clear rules, can turn volatility into resilience.

When we talk about economic downturns, the first step is knowing your risk profile — how much loss you can tolerate before panic sets in. Without this baseline, portfolio decisions are blind guesses.

• Aggressive investors accept larger drawdowns for the chance of higher returns.
• Conservative investors prioritize stability, even if returns are modest.

The principle is simple:

• More risky assets = higher potential returns but deeper losses during sell-offs.
• More safe-haven assets = lower returns but softer drawdowns in crises.

Example: In 2022, a tech-heavy portfolio lost over 30% as interest rates climbed, while portfolios with higher allocations to Treasuries or gold saw smaller declines. The difference wasn’t timing the market — it was risk profile alignment.

There’s no “right” or “wrong” portfolio — just what fits your tolerance.

• Risk-averse investors lean on safe assets: US Treasury bills, gold, the yen, or Swiss franc. These may underperform in bull markets, but when panic spreads, they act as shock absorbers.
• Risk-seeking investors tilt toward equities, growth sectors, or emerging markets, accepting higher volatility for greater long-term gains.

Example: During the 2008 crisis, gold rose by 6% while the S&P 500 lost nearly 40%. Investors holding even a modest 10–15% allocation to gold cushioned losses. By contrast, those heavily in equities suffered steeper drawdowns.

Equity investors can fine-tune risk by choosing between growth and value stocks.

• Growth stocks: Companies expected to expand revenues and profits faster than the market (tech firms like Tesla, Nvidia). They trade at high price-to-earnings (P/E) and price-to-book (P/B) ratios. They typically don’t pay dividends.
• Value stocks: Companies priced below their intrinsic value (banks, energy, consumer staples). They trade at lower P/E and P/B ratios and often pay dividends.

Example: In the 2020–2021 recovery, growth stocks surged — Tesla rose over 700% in a year. But in 2022, when inflation spiked and interest rates rose, value stocks such as ExxonMobil or JPMorgan outperformed, thanks to dividends and lower valuations.

For risk-tolerant investors, growth may be more rewarding but riskier. For cautious investors, value stocks provide steadier income and resilience during downturns.

While downturns can’t be predicted with certainty, investors often rely on leading indicators like the PMI to adjust portfolios.

What is PMI?
The Purchasing Managers’ Index (PMI) is a monthly survey of business executives in manufacturing and services. It measures whether economic activity is expanding or contracting:

• Above 50 = growth
• Below 50 = slowdown

Because PMI reflects current business activity and expectations, it is one of the earliest signals of shifts in the economy.

Example: In mid-2023, US manufacturing PMI slipped below 50 for several months. Investors rotated into defensive sectors like healthcare and utilities, which outperformed while cyclical stocks such as retailers and carmakers lagged.

Some investors prefer to hedge portfolios with options, treating them as insurance.

• Put option: the right (not obligation) to sell a stock at a set price by a certain date. It acts as a safety net if markets collapse.
• Cost: The higher the volatility, the more expensive the protection.

Example: In March 2020, professional investors who bought S&P 500 puts limited their losses when the index dropped 30%. Retail investors without protection had little recourse but to hold or sell at a loss.

⚠️ Options are complex and costly. They are better suited to experienced traders. If you don’t fully understand the mechanics, avoid them.

When markets drop, two schools of thought dominate:

• Dip-buyers: “Buy when others panic.” Works if the downturn is temporary.
• Top-sellers: “Sell into strength.” Works if the rally is short-lived.

Example: Buying the dip in March 2020 paid off as markets rebounded rapidly. But buying dips in 2008, before the final bottom, often led to deeper losses. Timing is everything.

Short-selling tops is even riskier. Losses are theoretically unlimited if prices rise. For most retail investors, it should be seen as a tactical move with strict profit targets, not a core strategy.

• Know your risk profile: it defines how much you can endure.
• Balance growth and value: each behaves differently in downturns.
• Watch PMI: above 50 = expansion, below 50 = slowdown.
• Rotate cyclicals and defensives: align with economic signals.
• Use hedges carefully: options can protect but are costly and complex.