Defensive stocks, also commonly called non-cyclical stocks, are a great way to add stability to your portfolio. They are not typically impacted by the fluctuations of the economy. Instead, they help your portfolio minimize loss.
While these stocks do not provide major growth potential, they do perform consistently even during times of economic decline when other securities are falling.
Why Are Defensive Stocks Important?
Defensive stocks are an important piece to an investor’s portfolio. They can help ensure your portfolio does not see a substantial loss in value during a recession. They can be relied on to provide regular returns, even though the returns are not as great as other types of stocks, like cyclical stocks.
Instead, their history of success during all market fluctuations makes them a valuable addition. They help keep you protected, no matter what the economy is experiencing.
Characteristics of Defensive Stocks
Traditionally, these stocks all follow the same pattern. They all provide stable returns, consistent dividends, and low volatility.
History of Stable Returns
The reliability of stable performance is one of the main characteristics of defensive stocks. Unlike cyclical stocks, these stocks do not follow the economic cycle during expansions and recessions. Your returns will not have major peaks and valleys and remain stable. You will see slow and steady growth.
Adding defensive stocks to your portfolio helps reduce volatility. When the economy turns downward, this type of stock helps protect your portfolio to keep you from facing major losses.
What Industries Have Defensive Stocks?
These stocks fit into industries of goods and services that consumers continue to utilize even when the economy is not doing well. They are things that you do not cut back on to save costs because they are required within your daily life.
Gas, water, electricity, waste management, and the like are all necessary services that must continue regardless of the economy. If you are looking to add a utility stock to your portfolio consider adding Entergy (ETR), National Fuel Gas (NFG), and/or NRG Energy (NRG).
When consumers begin to cut their budgets, they then focus only on necessities. Despite economic downturn, consumer staples like household goods, food and beverages, and even tobacco products tend to still thrive. Think of items that every person needs to survive everyday – cleaning supplies, toilet paper, groceries, personal hygiene products. These are not luxury purchases; they are essential for everyday living.
If you are looking to add a consumer staples stock to your portfolio consider adding The Clorox Co (CLX), Kroger (KR), and/or Colgate-Palmolive (CL).
Healthcare is another industry that is required during uncertain times. Because healthcare is always needed, this industry has performed well throughout recessions in the past. The healthcare industry includes pharmaceuticals, hospitals, insurance, and medical devices.
If you are looking to add a healthcare stock to your portfolio consider adding Merck (MRK), UnitedHealth Group (UNH), and/or Thermo Fisher Scientific (TMO).
Phones, internet, and cable service providers rarely see cutbacks during hard times. For the most part, this industry stays stable during economic volatility.
If you are looking to add a telecommunications stock to your portfolio consider adding Verizon Communication (VZ), American Tower (AMT), and/or Comcast (CMCSA).
Consumers look for a value when the economy plummets. Unlike luxury brands or other retailers who take a hit during a recession, discount retailers do well because they provide consumers with more bang for their buck.
If you are looking to add a discount retailer to your portfolio consider adding Big Lots (BIG), Dollar Tree Inc. (DLTR), and/or Dollar General Corp (DG).
Advantages of Defensive Stocks
There are many advantages of adding these type of stocks to your portfolio. Let’s review what defensive stocks bring to the average investor.
- Stability: Instability within the market tends to scare investors away from stocks they may deem as risky. However, defensive stocks offer stability to combat this. They add cushion to your portfolio that provides stable, consistent performance even in the midst of market swings.
- Low Risk: For risk-averse investors who are interested in protecting their wealth against loss, defensive stocks help maintain wealth while adding low-risk value and returns over time.
- Outperforms in Economic Downturns: There is one thing that is for certain, the economy will rise and fall over time. During these times, defensive stocks outperform cyclical stocks.
Disadvantages of Defensive Stocks
With great advantages comes the flipside, disadvantages. Both should be taken into consideration before you make investments in defensive stocks.
- Low Growth & Return: While defensive stocks provide stability, it comes at a cost. While these stocks may provide constancy over time, they rarely experience rapid growth, minimizing any chance that you will see big returns from them. Instead, they preserve their value.
- Underperform During Economic Growth: When the economy is booming, these stocks remain steady. They will not see major increases while other stocks are soaring. In fact, during times of major economic growth, defensive stocks can underperform.
- Overvalued: During downturns, defensive stocks often become overvalued. The reason for this is because many perceive these industries to be a safe bet. If you are thinking it, chances are other investors are thinking the same thing. When everyone begins investing in “safe bets” it can cause these stocks to become inflated.
Differences Between Defensive Stocks & Cyclical Stocks
While defensive stocks (non-cyclical stocks) are stable no matter the swings of the economy, cyclical stocks follow the cycles of the economy. This means that when the economy is doing well, so are cyclical stocks. However, when the economy is declining, these stocks take a toll.
Under the cyclical stock umbrella, you will find travel, high-end retail, automotive, and other industries. These are the industries that consumers cut back when the economy is experiencing trouble.
Adding Defensive Stocks to Your Portfolio
Defensive stocks are an important strategy to keep your portfolio diversified. However, they are only a small piece of the puzzle. Without adding other investment options, your portfolio will not see major gains to help increase your wealth and reach your goals.
To learn more about how to add defensive stocks to provide protection to your existing equities, reach out to your financial advisor.