The financial markets go through cycles, including expansions when profits are growing and downturns when the markets or economy are slowing. Market cycles place an investor's savings at risk for financial loss. By creating a defensive investment portfolio, an investor has a better chance of protecting his money throughout a market or economic slowdown. When the stock market or economy are experiencing a downturn, defensive investments can decline in value, too, but defensive investments generally do not experience as much financial loss as non-defensive securities.
Bonds are inherently defensive investments because, by design, they are meant to protect money while also producing income. United States Treasury bonds, which are issued by the federal government, have a history of being depended upon for steady interest payments because of the government's credit standing. The only way interest payments from U.S. Treasuries would stop is if the government defaulted on its debt, and that is an unlikely scenario. U.S. Treasuries may not produce returns that are as high as bonds issued by other countries, or by corporations or municipalities, but they are the most likely to maintain interest payments through economic downturns.
In addition to individual stocks and bonds, an investor can add investment funds to a portfolio. Inverse funds are funds containing financial securities that move inversely to the stock market, which means they increase in value when the stock market loses value. Inverse funds offset losses stemming from stocks, and earn the highest profits when they are added at the cusp of stock market downturn. If an investment portfolio also contains non-defensive securities, such as most stocks, an inverse fund will protect the fund from some of the dramatic price swings that volatility produces, according to a 2010 Money Morning article.
A defensive investment portfolio does not have to avoid stocks altogether. Dividend stocks, for instance, which are companies that use their extra earnings to reward investors with income, are defensive. Companies in many sectors of the economy, including health care and technology, continued paying dividends even throughout the recession of 2008, according to a 2012 Kiplinger article. A Wall Street Journal article, also from 2012, said that during times of extreme economic uncertainty, investors are willing to pay as much as 25 percent more than usual for dividend stocks just to gain exposure to the defensive nature of dividend stocks.
Commodities are physical assets, including energy assets and agricultural items, whose values are not correlated to stocks or bonds, which means they trade independently from other asset classes. Instead of being driven by corporate profits or interest rates, commodity prices are influenced by the conditions in an economy, in addition to demand for trade. Commodities serve as a defense against economic inflation, which occurs when the value of a currency weakens and that currency cannot buy as much as it did before. Commodities rise in value alongside inflation, which increases their value in an investment portfolio.
- Reuters: PIMCO's Gross Shifts to Defensive Investment Model
- Money Morning: Defensive Investing -- Beware of Municipal Bonds
- Money Morning: Top Profit Plays for A Defensive-Investing Portfolio
- The Wall Street Journal: Investors Testing Limits of Defense
- The Wall Street Journal: As Stocks Head Higher, So Do The Risks
- Kiplinger: Scoop Up Dividends
- J.P. Morgan: Investing in Commodities -- The Search for Diversification
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.