DEFINITION of Defensive Investment Strategy
A defensive investment strategy is a conservative method of portfolio allocation and management aimed at minimizing the risk of losing principal. A defensive investment strategy entails regular portfolio rebalancing to maintain one's intended asset allocation; buying high-quality, short-maturity bonds and blue-chip stocks; diversifying across both sectors and countries; placing stop loss orders; and holding cash and cash equivalents in down markets. Such strategies are meant to protect investors against significant losses from major market downturns.
BREAKING DOWN Defensive Investment Strategy
With an offensive or aggressive investment strategy, in contrast, an investor tries to take advantage of a rising market by purchasing securities that are outperforming for a given level of risk and volatility. An offensive strategy may also entail options trading and margin trading. Both offensive and defensive investment strategies require active management, so they may have higher investment fees and tax liabilities than a passively managed portfolio. A balanced investment strategy combines elements of both the defensive and offensive strategies.
Defensive Investment Strategy and Portfolio Management
A defensive investment strategy is one of several options in the practice of portfolio management. Portfolio management is both art and science; portfolio managers must make critical decisions for themselves or their clients, taking into account specific investment objectives and capabilities and selecting proper asset allocation, balancing risk and potential reward.
Many portfolio managers adopt defensive investment strategies for less risk averse clients, such as retirees without steady salaries. Defensive investment strategies could also be appropriate for those without much capital to lose. In both cases, the objectives are to protect existing capital and keep pace with inflation through modest growth.
Selecting investments in high-quality short-maturity bonds, such as United States Treasury notes (T-notes) and blue-chip stocks (securities of large, well-established and financially sound companies like IBM Corp., Coca-Cola Co. and Boeing Co.) are solid tactics. Holding a moat of cash and cash equivalents, such as U.S. Treasury bills (T-bills) and commercial paper (unsecured, short-term debt instruments that companies often issue to meet short-term liabilities) can also help to keep pace with inflation and protect the portfolio in down markets.
In contrast, portfolio managers may adopt an aggressive investment strategy with clients that have more capital that they can afford to lose. This could occur if the market takes a turn for the worse or riskier investments like high-growth technology stocks, venture capital, alternative investments, and emerging market debt do not pan out. Both wealthier clients and younger clients are candidates for more aggressive investment strategies. Younger clients generally have longer time horizons, steadier salaries, and can afford to take more risks.