10 Investments and Strategies That Go Great with Stocks
Some type of stock exposure is good for virtually any portfolio. But you must remember that your total financial portfolio should have other investments and strategies that are not stocks at all. Why?
Diversification means you have other assets besides stocks so you’re not 100 percent tied to the whims and machinations of the stock market. All too often, too many investors have too much exposure to the stock market. That’s fine, of course, when the stock market is raging upward, but potential down moves are there too. Therefore, you should consider investments and strategies that complement your stock investing pursuits.
Covered call options
Writing a covered call option is a great strategy for generating income from a current stock position (or positions) in your portfolio. A call option is a vehicle that gives the call buyer the right (but not the obligation) to buy a particular stock at a given price during a limited time frame (call options expire). The buyer pays what’s called the premium to the call seller (referred to as the call writer). The call writer receives the premium as income but in return is obligated to sell the stock to the buyer at the agreed upon price (called the strike price) if called upon to do so during the life of the option.
To find out more about writing call options on your stock positions, check out High-Level Investing For Dummies.
A put option is a bet that a stock or ETF will fall in price. If you see the fortunes of a company going down, a put option is a great way to make a profit by speculating that the stock will go down. Many use puts to speculate for a profit, while others use put options as a hedging vehicle or a form of “portfolio insurance.”
If you’re holding a stock for the long term but you’re concerned about it in the short term, then consider using a put option on that stock. You’re not hoping the stock goes down; you’re merely using a form of protection for your stock-holding. If the stock goes down, the put option will rise in value. What some investors do is then cash out the put option at a profit and use the proceeds to buy more shares of that stock because the stock’s price is lower and possibly a buying opportunity.
Having some money in the bank or just some cash in your brokerage account comes in handy no matter what’s happening with the stock market’s gyrations.
Currently, interest rates on savings accounts and similar bank vehicles are abysmally low, so cash isn’t a great investment. However, cash is an integral part of your overall wealth-building approach for several reasons:
- Cash you hold on the sidelines is necessary when buying opportunities present themselves during the ebbs and flows of the stock market.
- Cash is necessary for an emergency fund in your overall financial planning picture. Not enough folks have an emergency or “rainy day” fund, which means a hundred different things (big medical expense, job layoff, and so on) could cause them a cash flow problem.
- Cash is a good holding during deflationary times. When prices are low or going down, your cash’s buying power gets stronger.
EE savings bonds
The EE savings bond is issued by the U.S. Treasury and is a great vehicle, especially for small investors (you can buy one for as little as $25). It’s a discount bond, meaning that you buy it at below its face value (the purchase price is 50 percent of the face value) and cash it in later to get your purchase price back with interest.
The interest rate paid is equivalent to 100 percent of the average five-year Treasury note rate. If this rate is at 2 percent, then you get 2 percent. To get the full benefit of the rate, you must hold your EE bond for at least five years. Here are several benefits of an EE bond:
- The interest rate isn’t fixed. Because the rate is pegged to Treasury note interest rates, it will rise (or fall) along with that rate. In the event that interest rates rise (which is a possibility for 2016 and beyond), EE bonds would benefit.
- The interest you earn on EE bonds is typically higher than a conventional bank account.
- EE bonds are free from state and local taxes. If you use the bonds for education, much of the interest can be tax-free.
For more details on the EE savings bond, head over to the U.S. Treasury’s site on savings bonds.
In the age of low-interest rate debt investments (such as bonds in general), the I savings bond (the “I” stands for inflation) is a different wrinkle altogether. This is a “sister” to the EE savings bond, and it’s also issued by the U.S. Treasury. The twist here is that the interest rate is tied to the official inflation rate (the Consumer Price Index, or CPI). If the CPI goes to 3 percent, then the interest rate on the I bond goes to 3 percent. The interest rate gets adjusted annually.
At the time of this writing, the CPI has been relatively low, and the environment is generally deflationary (a period of low prices), so the I bond’s interest rate has been under 1.5 percent.
The I bond is good for the coming years because inflation can easily return because of a variety of factors (increasing money supply and so on), and the I bond can be a solid part of your overall portfolio.
Sector mutual funds
A mutual fund is a pool of money that’s managed by an investment firm; this pool of money is invested in a portfolio of securities (such as stocks or bonds) to reach a particular objective (such as aggressive growth, income, or preservation of capital). The investment firm actively manages the fund by regularly making buy, sell, and hold decisions in the fund’s portfolio.
A sector mutual fund limits its portfolio and investment decisions to a particular sector such as utilities, consumer staples, or healthcare. It’s your task to choose a winning sector, and the job of choosing the various stocks is left to the investment firm.
Starting with only a few hundred bucks, you can have a theme-based portfolio that can augment your portfolio of individual stocks. Motif investing is a relatively new twist on investing. It gives you the convenience of investing in a pre-structured portfolio that’s designed to do well given a particular expected event, trend, or worldview that will unfold.
If you believe, for example, that interest rates will rise, you can with a single motif have a basket of stocks that would optimally benefit from that event. If you believe that inflation will rear its ugly head, then you can consider a motif that intends to benefit from that outcome.
Bearish exchange-traded funds
Investors can do plenty of things, both before and during tumultuous market times. If you’re invested in quality stocks, then you shouldn’t panic, especially if you have a long-term outlook. But hedging to a small extent can be a good consideration.
Exchange-traded funds (ETFs) are a good companion vehicle in your stock portfolio, and their versatility can become part of your overall strategy. If you believe that the stock market is or soon will be in difficult times, then consider a bearish stock market ETF. A bearish (or inverse) stock ETF is designed to go up when stocks go down. If stocks go down 5 percent, then the bearish ETF goes up by a similar inverse percentage (in this case, 5 percent).
Dividend yield exchange-traded funds
Strong, profitable companies that have consistently raised their dividends in the past tend to reliably keep doing so in the future. Many companies have raised their dividends, or at the very least kept paying them, year-in and year-out through good times and bad. Dividends are paid out from the company’s net earnings (or net profit), so dividends also tend to act as a barometer gauging the company’s financial health, which basically boils down to profitability.
Finding good dividend-paying stocks isn’t hard. You can also find them with stock screening tools. However, investing in a strong basket of dividend-paying stocks by checking out dividend yield ETFs can be a good idea. A dividend yield ETF selects a basket of stocks based on the criteria of dividends — how consistently they’re paid and continuously raised. They make it easy to include dividend-payers in your portfolio with a single purchase.
Consumer staples exchange-traded funds
You should consider having investments in your portfolio that are defensive in nature — investments tied to those products and services that people will keep buying no matter how good or bad the economy is. Sure, consider that sexy, high-tech gizmo stock if you like, but offset that with stocks of companies that offer food, beverages, water, utilities, and so on.