Over the last few years, it’s been easy to make money in a Stocks and Shares ISA. With major stock market indexes like the FTSE 100 surging, and individual stocks such as Rolls-Royce and Nvidia soaring, it’s been a brilliant environment for investors.
Looking ahead however, there’s a chance that stocks could come crashing down, wiping out recent gains. So it could be time to make some precautionary moves. And such moves might turbocharge a portfolio.
Two huge risks
The way I see it, there are two major risks on the horizon right now. The first is a potential economic slowdown as a result of the conflict in the Middle East.
If this conflict continues on for months, and oil prices remain high, there are likely to be implications for the economy. That’s because high oil prices essentially act as an extra tax on businesses and consumers.
The other major risk is an AI-related, white-collar job wipeout. I’m more concerned about this risk, personally.
Say, for example, 20%–30% of white collar jobs were to be automated in the next few years before the new jobs that inevitably come with tech revolutions kick in. Consumer spending (the fuel that keeps the economy ticking over) would most likely fall sharply. This would almost certainly impact the stock market.
Now, I don’t want to sound too negative here. Because neither scenario may materialise. However, in my view, it’s a good time to focus on risk management. Being prepared could help you avoid losses and capitalise on opportunities if things get ugly.
Basic risk management
As for how we can prepare, thinking about asset allocation and diversification is a good place to start. Remember, a Stocks and Shares ISA doesn’t need to be 100% invested in stocks.
Within this type of account, an investor can put money into bonds, money market funds, gold, and many other asset classes (or just leave it in cash). By building a balanced portfolio, risk levels can be lowered.
Diversification’s another powerful risk management tool. By spreading money out across different sectors and stocks, investors can reduce their equity risk levels.
Note that some sectors tend to hold up better than others in a crash. ‘Defensive’ sectors include Consumer Staples and Utilities.
The opportunities
Another smart move is to construct a ‘stocks-to-buy’ list. This can help you stay disciplined and objective when markets become volatile, and puts you in a good position to capitalise on opportunities.
A tip here – don’t just write down ticker symbols. Next to each stock, put down a target price and a one-sentence thesis on why you want to own it.
One stock on my own list is Rolls-Royce (LSE: RR.). The reason I want to own it is that the company looks well placed to benefit from spending on defence (which is relatively uncorrelated to economic growth).
I’m also drawn to the company’s nuclear energy exposure. It’s looking like the nuclear industry is going to boom over the next decade and this company’s an industry leader.
As for my target price, I’d be interested in buying between 800p and 1,000p. That would translate to a price-to-earnings (P/E) ratio of 20-25 using next year’s earnings forecast.
Of course, if the global economy tanks, the company may not deliver on current forecasts. We could see weak conditions in its civil aerospace division. However, buying at 800p would give me a bigger margin of safety than buying at today’s share price of 1,230p.
