If Trump and Clinton supporters have anything in common at all, it's a sense of dread. Yet the next president's policies and temperament aren't their only worries; they fear what a period of uncertainty would do to their investments.
And don't expect it to get much better, even after Americans cast their ballots. A long but listless bull market now in its eighth year, plus a Federal Reserve on the precipice of another interest rate hike, mean ordinary investors might be wise to take some tips from the pros and look for ways to ride out a turbulent period.
While there's no perfect way to escape all the bumps in the road, expert traders use a range of strategies from simple to sophisticated to dampen the shocks. Some involve "put" and "call" stock options that can seem scary to an investor accustomed to straight stock trades or buy-and-hold mutual funds, but options strategies like covered calls and collars are in fact conservative.
Here are six strategies investors can use to safeguard a portfolio in uncertain times.
This one has history on its side. Stocks get hammered from time to time, but the broad market has always recovered. So if you are well diversified with individual stocks or a set of mutual funds, the easiest strategy is to just wait for things to get better.
"Ordinary investors are best served long term to simply stay put and ride out the volatility," said Robert Johnson, president and CEO at The American College of Financial Services
in Bryn Mawr, Pennsylvania. "Volatility increases when uncertainty increases, and the uncertainty of what might happen if Trump prevails in an upset in the presidential election is causing investors angst."
Though many see Clinton as less of a wild card, Johnson said that a Clinton win could roil the markets as well, by aggravating worries about higher taxes, more regulation and a higher minimum wage.
There's plenty of precedents about the worst that can occur that can actually, ironically, reassure investors. In the past, the broad market has taken an average of only 10 months to recover from a 10 percent correction, and the average bear market — a loss of at least 20 percent — has lasted only 15 months. Even the bear market of 2008, when stocks lost half their value, was over quickly, and the S&P 500 has nearly tripled since its March 2009 low, making it costly for those who fled to the sidelines and sat out the rebound.
Diversification reduces risk, and certain types of holdings benefit from factors that hurt others. Some experts recommend significant stakes in high-quality bonds and dividend-paying stocks, as the income is likely to continue even if the holding loses value in volatile times.
Worried Investors can defend themselves by moving some money out of their riskier holdings and into cash, which can be kept safe in an FDIC-insured bank account or a money market fund. Then, if all works well, it can be put back into stocks while prices are down, though experts warn it's terribly hard for even the pros to spot the bottom. One variation on this theme could be put to work right now: Have year-end fund distributions held as cash rather than automatically reinvesting in more shares.
Some stock sectors, such as utilities, energy, food and consumer goods, are considered safer because they involve products that people buy even in uncertain times, unlike cyclical stocks of companies with products people can by later, like cars and airline tickets. So a nervous investor might shift to those sectors and out of volatile issues, like technology.
In their book "Invest with the Fed: Maximizing portfolio performance by following Federal Reserve policy," Johnson and his co-authors, Gerald Jensen of Creighton University and Luis Garcia-Feijoo of Florida Atlantic University, found that defensive stocks performed much better than cyclical stocks when the Fed raised rates, as is likely over the next year or so. "Given that most market pundits expect a rate hike in early December, moving from cyclical stocks and into defensive stocks seems prudent," Johnson said.
A put option gives its owner the right to sell 100 shares of stock or of an exchange-traded fund at a set price anytime for a period of months to years. So an investor with a broad portfolio could buy puts on an ETF like SPDR S&P 500 ETF Trust (SPY) that tracks the Standard & Poor's 500. If that index fell, you could buy the SPY shares at the lower price and use the put to sell them at today's price, earning a profit on the difference to offset any loss in your portfolio. Or you could just sell the put contract, which would gain value as the index went down.
"The first thing that people tend to look at ... if they have a broad-based portfolio is buying puts," said Russell Rhoads, director of education for the Options Institute, the education arm of the Chicago Board Options Exchange.
If you need an example of a conservative investor who sees value in the use of options, consider Berkshire Hathaway's long-time use of billion-dollar-plus positions in puts on major equity indexes, which Berkshire chairman and CEO Warren Buffett discussed in his 2008 annual letter to shareholders.
Calls are the opposite of puts, giving their owner the right to buy shares at a set price for a given period. The person who creates, or "writes," a call contract promises to sell the shares at that price if the call's buyer chooses to exercise the option. A call is "covered" when the writer owns the shares rather than having to race out to buy them if the option is exercised. The covered call writer receives a payment, or "premium," for the option.
Earning that premium can boost the holding's return, or it can reduce the sting if the share price falls, said Tom Gentile, editor of Power Profit Trades, a newsletter for options traders.
He pointed to Netflix, a volatile stock that soared after its recent announcement of better-than-expected earnings. On Oct. 17, the shares were trading at about $100, and a call good until January 2018 with a $100 strike price sold for a $19 premium. An investor with 100 shares could therefore have earned $1,900 by selling one covered call contract.
"So you can immediately make a 20 percent income by selling those call options against the stock," Gentile said. The call writer would come out even if Netflix fell by 20 percent.
"Covered calls are one of the first things an options investor learns," Gentile said.
The put strategy above has one major drawback: the cost of the premium paid for the option, and premiums have gone up substantially in the face of uncertainty about the presidential election, just as it would cost more to insure a house with a hurricane bearing down.
In August it cost $3.76 per share to insure against any loss in the S&P 500 over the next 90 days, Gentile said. On October 20, the same 90-day insurance cost $5.48 a share.
But with a collar strategy, you can reduce the cost of insurance. according to Frank Tirado, vice president for Education at The Options Industry Council (OIC), which offers educational materials on options trading. A collar involves buying a put and simultaneously writing a call on the same shares. The premium earned writing the call offsets all or part of the premium spent on the put.
Another way to reduce insurance cost is to use puts that would require you to take some loss before the protection kicked in. With a stock trading at $100, a put with the right to sell at $90 would be cheaper than one to sell at $100, for example. So the investor willing to take a 10 percent loss could save money by purchasing the cheaper put. (One with an $80 or $70 strike price would be even cheaper.) The investor would still be protected from deeper losses, because even if the stock fell to $50, or even zero, the put would guarantee he could sell for $90.
Insuring a portfolio is like insuring a house or car, Tirado said: "You have an asset. You have to think about how much insurance do I really need? Do I really need to protect 100 percent of my portfolio, or is 60 percent enough? Fifty percent?" He compared partial insurance on investments to accepting a larger deductible on a home or car.
— By Jeff Brown, special to CNBC.com