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Ten ways to protect your portfolio from fluctuating markets

A pedestrian carries an umbrella on a rainy day in London May 27, 2014.

NEIL HALL/Reuters

Worried about the stock market? Unnerved by wild swings in bonds?

Stocks rebounded Wednesday despite a gathering storm in global bond markets, where some participants fear a run on bond mutual funds and exchange traded funds as investors all rush for the exit. The stampede may have started with news reports Wednesday that U.S. investors had pulled $1.5-billion (U.S.) from the two biggest high-yield bond ETFs over the past week. The concern is that the jitters could spread to the stock market, where valuations are historically high.

Before you sell everything and head for the hills, reflect for a moment on what you have in your portfolio and why you bought it in the first place. Here are 10 tips from investment pros on shoring up your savings and soothing your troubled mind.

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1. If you have a margin account and have borrowed from your dealer to buy stocks, bonds or investment funds, pay that money back now. "Your first margin call will never be your last," says Bill Carrigan, an independent stock market analyst and founder of Getting Technical Info Services. "The best thing is to reduce margin debt before you're forced to."

2. Raise a bit of cash. If you have an actively managed fund, the manager may well be doing this for you. "I'm looking for places to batten down the hatches a bit," says Tom Bradley, president of Steadyhand Investment Funds Inc. and manager of the low-cost Steadyhand Founder's Fund, a top-rated balanced fund. "One thing that is a perfectly viable option – Warren Buffet does it – is to hold more cash in short-term instruments than you otherwise would," Mr. Bradley says. In the Steadyhand Founder's Fund, "we've gradually taken money off the table – more in bonds than stocks," he adds. Mr. Bradley has shifted the fund's target asset allocation from 60 per cent equities, 35 per cent bonds and 5 per cent cash to 55 per cent stocks, 25 per cent bonds and 20 per cent cash.

3. If possible, try to hold investments that don't all move in the same direction, Mr. Carrigan recommends. So-called non-correlated assets will help buffer a portfolio in turbulent markets. If your portfolio is largely interest-sensitive – utility stocks and real estate investment trusts, for example – consider taking some profits. Ditto if you're loaded up on over-the-moon tech stocks.

4. If you have substantial bond holdings, consider shortening duration, or checking whether your fund manager is moving to shorter-term securities. Consider a ladder of one- to three-year bonds or guaranteed investment certificates (GICs).

5. Take a long, hard look at your more exotic investments, particularly those designed to offer exceptionally high yields. "There are so many bond-like products" that have become riskier, Mr. Bradley says. "Many are very illiquid," meaning they could be difficult to sell in a down market. "There are going to be pockets where it's ugly."

6. If your bond holdings look a tad junky, consider upgrading. "We're not chasing yield as much as accepting a reasonable yield and making sure the quality of the credits [bond issuers] is very high," Mr. Bradley says. "This might bring the yield of the portfolio down, but over the full cycle it will benefit clients."

7. Consider diversifying internationally. With such a broad array of global funds available, you don't have to stick with the 10 TSX sectors, Mr. Carrigan says. "You might need some help from an adviser for that, but look for markets that are out of whack. The obvious one last year was Japan, which has been counter-cyclical for the past 20 years," he adds.

8. Shift away from overcrowded trades. Investors tend to all pile into the same stocks, sectors or markets, Mr. Carrigan says. Markets in the United States are a prime example. "Make sure you're not loaded up with the same group of stocks."

9. Rebalance your assets regularly in good markets and bad. "I'm not convinced that anyone can consistently tell when we're near the top of the market," says Warren MacKenzie, a principal at HighView Financial Group in Toronto. "But if you consistently rebalance the portfolio when your allocation breaches your target range, you'll always be in the right asset mix." The rebalancing process takes the emotion out of investing – which is critical in turbulent markets – and "forces you to buy low and sell high, thereby locking in profits from time to time," Mr. MacKenzie says.

10. Prepare yourself psychologically for ups and downs by reviewing your goals and your investment policy. "The first thing people should do is say when (prices fall) not if," Mr. Bradley says. Think about what you'll do when your equity fund is down 20 per cent. "Use the word 'when' out loud," he says. When the inevitable correction comes, make sure you make your RRSP and TFSA contributions and rebalance your holdings to buy more equities. "Write it down so when the headlines are terrible, you'll have something to lean on," Mr. Bradley says. Sophisticated investors may buy put options, inverse exchange-traded funds or hedge funds, but for most investors, the best defence may well be a well-balanced portfolio. "A portfolio properly structured should provide a natural hedge," Mr. Carrigan says.

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