In these unstable economic times, it could be a good time to do some investing research. So, you might be wondering, what are defensive stocks? In simple terms, defensive stocks are particular stocks that provide steady earnings and consistent dividends regardless of the way the stock market and economy are performing overall. Because of their stable performance, they are insular from business cycles and are more recession-proof than typical stocks. Because of this, defensive stocks function as their name would suggest: they defend your portfolio against losses. They are also called non-cyclical stocks.
Defensive investments are typically established companies that provide goods and services that consumers always need or want, so they are always in demand. When the economy takes a downswing, investors rush to these stocks as they are expected to perform well. They may not offer huge gains in comparison to more aggressive stocks, but defensive stocks could be considered a safer investment in times of market turbulence.
So let’s take a detailed, in-depth look at defensive stocks, their purpose, industries that provide them, and any advantages and disadvantages they may have.
What is the purpose of defensive stocks in your portfolio?
Let’s look at why someone might have defensive stocks within their portfolio.
In essence, like their namesake, defensive stocks defend your portfolio! They can help hedge against financial risk and assist in diversifying your portfolio, counterbalancing any potential losses you may incur, especially during a recession. They have a safeguarding role with solid foundations for lasting value, functioning as assets that can rescue variability in your portfolio. Think of defensive stocks as a shield!
Because of their nature, defensive stocks might be a good asset in your child or teen’s portfolio, minimizing any risk they may incur as a beginner investor. A great tool for this is Invstr Jr, our investment app for kids, which is a great way for parents to open investment accounts for minors. Invstr Jr makes investing fun and safe for the whole family.
Sectors that provide defensive stocks
You might not be familiar with the difference between an industry and a sector. Well, a collection of companies makes up an industry, such as the supermarket industry. A sector is made up of industries. For example, the Consumer Staples sector is made up of industries such as supermarkets and restaurants.
There are eleven US sectors, and some have a more consistent consumer demand than others year-round due to the specific goods and services they offer. This includes things like prescriptions, electricity, water, and groceries. Sectors include Healthcare, Utilities, and Consumer Staples, to name a few. If you want to invest in defensive stocks, it could be beneficial to research which companies perform well in these sectors.
Due to its consistent demand, healthcare is a necessity and is largely unaffected by downswings in the economy. This sector includes companies that provide medical services, manufacture drugs or medical equipment, or provide insurance. Obviously, while not all healthcare stocks are without risk, this sector can offer strong defensive stocks.
The utilities sector includes companies that provide water, electricity, and heating. It even encompasses renewable energy companies that provide products such as wind turbines and solar panels. As you can imagine, companies in this sector can offer some fantastic defensive stocks as these services are required during all economic periods.
Consumer staples is a sector that is unlikely to ever be eliminated, so it hosts a range of defensive stocks. It includes a variety of products such as food and drink, household items, toiletries, and tobacco products. Grocery shops stock shelves full of these companies’ products. People are often unwilling to cut these items from their budgets, so these defensive sector stocks are usually very steady.
Defensive stocks are also common in the telecommunications sector, which includes companies that provide phone, cable, and broadband/internet services. Although they have the potential to be volatile, these are services that consumers never stop needing, so these defensive sector stocks typically have stable revenue.
Shelter is a basic need for human beings, and people will always need houses to live in, regardless of the shape of the economy. So, as you may have guessed, many defensive stock companies can be found in this sector. Furthermore, real estate companies are required to pay dividends to their shareholders out of their taxable income.
Defensive investments can also be found in the discount retailers sector. When the economy takes a downturn, buyers look for more affordable options. Because of this, businesses that help consumers get great deals perform better than other retailers and can be an excellent opportunity for defensive stocks.
Examples of defensive stocks
Let’s take a look at some examples of defensive stocks:
One example of a defensive stock is Coca-Cola! This well-loved consumer staple sector beverage is recognized and enjoyed by people of all ages and financial situations across the US. Risk-averse investors love this stock because it can typically be depended upon for safe returns.
Another consumer staple defensive sector stock is Costco, a stock that has many Wall Street fans. This superstore chain has shown its adversity to inflation as a defensive stock.
Other defensive investments include the Walt Disney Company, a business that boasts not only the ‘Most Magical Place on Earth’ – Disney World – but also a popular streaming platform and beloved merchandise and apparel line.
If you’re interested in trading in defensive stocks, you can identify them by their beta. This is a measure of their volatility compared to the market. Defensive stocks will usually have a lower beta than other stocks, as they are less affected by downswings in the market. To help you narrow your search, you might focus on a particular sector’s defensive stocks.
You can do all this in Invstr’s Instrument search – picking whichever sector you’re interested in trading within, and analyzing how a company is performing.
Finding the right defensive stock ultimately depends on your personal investing style and your long-term goals.
What are the advantages of defensive stocks?
After all this information on defensive stocks, let’s break down what makes them advantageous for investors:
Of course, with all trading comes the possibility of risk and losses. However, these types of stocks have comparatively less risk than aggressive stocks. Because of their steady nature and low volatility, they’re less likely to drop in value when there are events that cause a downturn in the economy. During a recession, defensive stocks can protect you from further losses. Skilled investors, risk-averse investors, and beginners alike may choose to protect their portfolios with these ‘shields’.
Due to their low volatility, it can be easy to predict how these stocks will perform. The returns that can be made on defensive stocks are usually slow-going and stable – like dividends, if the company pays them out – meaning that you can predict how your investments in defensive stocks will perform over time. Because of this, defensive stocks might prove good portfolio assets if you are working towards retirement or a specific financial target.
Because of the nature of defensive stocks, you might have guessed that these are very accessible for investors who are just starting out, investors who dip in and out of stock trading, or investors who do not routinely follow trends in the stock market.
What are the disadvantages of defensive stocks?
Like all things in the world, defensive stocks also have some disadvantages:
Because of their slow growth, defensive stocks often provide smaller gains during a bull market in comparison to more aggressive stocks and often perform below the market.
Defensive stocks may suffer in times when inflation is high. This is because even if companies raise their dividend rates, the rise may be small. Rising inflation becomes a concern when an investor receives the same dividend each year as their value will decrease.
Sometimes, investors rush to defensive stocks with such ardor in times of economic decline that they can become overvalued. So the stock can become inflated and more expensive than it is actually worth.
At the end of the day, defensive stocks are worth your consideration. It may be that you have to do some research into what sectors, companies, and defensive investments are right for you, but the bottom line is defensive stocks will typically perform well despite changes in the wider market.
They are just one way of mitigating your portfolio risk, and you should look into individual companies to see how they are performing.
If you are looking for stocks that might be suitable for your child’s portfolio, you could research defensive stocks as an option for your kid that provides minimal risk. A great way to do this is through Invstr Jr – the best investing app for kids!
Like everything, balance is key!
Please remember that investing puts your capital at risk and can lead to losses.