3 Ways to Slash Your Risk Despite the Negative Investing Outlook

With everything from the Greek debt crisis to worries about China's growth roiling the markets these days, the investing outlook seems to get shakier by the minute. And that means the same old tricks won't work any longer.

It's not going to be enough, for example, to simply pick stocks or spread your risk among large-cap, small-cap and a blend of domestic and international stocks and bonds thrown in for good measure.

Those things don't work when everything goes down at the same time -- a painful reality that investors experienced during the financial crises of 2000-2003 and 2007-2009.

If we've all learned one thing from those crises, it's that stability matters when it comes to producing higher, more consistent returns -- especially in a world in which the investing outlook is clouded by uncertainty.

But there are three strategies that can bolster your personal investing outlook and help you even out the rough sailing I see ahead.

Let me show you what I mean.

Three Strategies You Can't Ignore

The three strategies I'm talking about represent a break with the so-called "tried-and-true" approaches that were once in every investor's playbook, but that don't seem to work so well in today's markets. So I'm recommending that you replace those old tactics with these three new ones, which will have you:

• Build your own "hedge fund."
• Adopt a "long/short" bond strategy.
• And consider a solid "alternative" to alternative investments.

Let's take a look at each one -- starting with the personal hedge fund.

Creating your own hedge fund is actually much simpler than you'd think. To illustrate, let's take a look at how a portfolio that was evenly apportioned in large caps, small caps, growth, value, domestic and international stocks (in other words, a portfolio allocation that's fairly standard fare among investors) would have performed from 2007 to 2009, a period in which the Standard & Poor's 500 Index declined "only" 50%, according to Kiplinger's Personal Finance Magazine.

This portfolio -- diversified in a way that's supposed to diffuse risk -- would actually have plunged a full 57% during that same stretch.

The message is clear. In a world in which entire countries are leveraged to the hilt, in which out-of-control financial institutions are calling the shots, and in which clueless regulators are playing a constant game of catch-up, that diversification strategy is no safe harbor.

What you really need to do is seek out investments that move in opposite directions when the investing outlook turns negative.

Hedge funds do this all the time by combining investments that are in favor with those that aren't, pairing those things they like against those things they don't in what's called a classic "long-short" strategy. This helps them generate higher, more-consistent profits, regardless of whether the markets want to run higher or fall lower. And it's a strategy that doesn't force you to try and "time" the markets, or take excessive risk.

You can do the same thing using two investments that are among my personal favorites:

• The Vanguard Wellington (VWELX).
• The Rydex Inverse S&P 500 Strategy Fund (RYURX)

Vanguard Wellington is one of the world's best-run mutual funds and has a remarkable track record of stability, solid returns and high income that dates back to 1929, making it one of the longest-established mutual funds in existence today. At a time in which exchange-traded funds (ETFs) are all the rage, many folks scoff at old-fashioned mutual funds. But with an expense ratio of only 0.30%, the Vanguard Wellington is one of a very few funds I believe to be worth it.

The Rydex Inverse S&P 500 Fund is one of a specialized class of so-called "inverse" investments, and is truly "negatively correlated" to the markets, which means that it rises when the S&P 500 falls. Its expense ratio is 1.44%.

For the sake of discussion, let's say you put $50,000 in each on Jan. 1, 2000, and then let the funds ride undisturbed until June 24 of this year. Combined, you'd have an expense ratio of 1.74%.

But even more important, you'd have a 4.18% return over the last 11 years -- compared to the S&P 500, which suffered a 12% decline (see the chart below).



In other words, had you split your money between these two negatively correlated choices on Jan. 1, 2000 and just walked away, you'd have trounced the S&P 500 by nearly 16.2% over the last 11 years. That's a much simpler and more effective strategy than anything most folks were employing at the time, which was to diversify their money across the key asset classes and then just hold on.

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