We usually steer clear of "most/least/best" lists, but we get why they’re tempting. So, in this article, we’re diving into some of the most popular defensive asset classes. In doing so, we're aiming to give you the insights you need to balance your portfolio. Let’s explore your options.

What is a defensive asset?

A defensive asset is an investment that tends to maintain its value or even perform well during economic downturns . These assets, which we’ll dive into further down, are valued for their stability and lower risk.

Unlike high-growth investments, defensive assets focus on preserving capital and providing steady, reliable returns. In periods of market volatility, they aim to offer a buffer, potentially protecting your portfolio from significant losses.

What role do defensive assets play in an investing portfolio?

Defensive assets can play a vital role in an investment portfolio, acting as a possible safeguard during periods of market volatility. While growth assets aim for high returns, they also come with higher risks. Defensive assets, on the other hand, are designed to:

• Preserve capital: Protect your investment from dramatic losses during economic downturns
• Provide stability: Offer steady, predictable returns, even when markets are turbulent
• Reduce portfolio risk: Balance out more volatile investments, creating a more resilient portfolio

These assets could be particularly useful for investors with lower risk tolerance or those nearing retirement, as they may help ensure financial security during uncertain times.

Which assets are considered defensive?

Several assets fall into the defensive category, including:

Cash

Cash is considered by many to be the ultimate defensive play, offering excellent liquidity and capital preservation. In a world where financial markets can be unpredictable, holding cash can provide a sense of security, as it's virtually risk-free.

However, there’s a catch: cash doesn’t grow. In fact, it loses purchasing power over time due to inflation, which can significantly erode its value. The opportunity cost of holding cash is high, especially when other asset classes are delivering strong returns. While investors may be able to earn returns on cash via fixed term deposits, the returns have historically not matched the share market. What's more, the rate of return will always be at the mercy of interest rates.

Perceived defensive factor : High. Cash is a pretty safe bet for capital preservation and liquidity, but it’s vulnerable to inflation and offers minimal returns.

Bonds

Bonds are a cornerstone of defensive investing, prized for their typical stability and reliable returns. They generally offer a predictable income stream through fixed-interest payments, making them a go-to choice for those seeking safety in turbulent markets. Government bonds, in particular, are seen as low-risk, backed by the full faith of sovereign nations. This low volatility makes them attractive among all kinds of investors, especially when economic uncertainty looms.

However, bonds aren't without their downsides. Inflation can erode the real value of the income they provide, and rising interest rates can push bond prices down. While government bonds are typically easy to trade, corporate bonds can be less liquid. In terms of returns, bonds often lag behind other asset classes, especially in low-interest-rate environments, making them a more conservative choice.

Perceived defensive factor : High. Bonds are a classic defensive asset, generally offering stability and income, particularly in times of economic stress.

Gold

Gold is popular in times of crisis, earning a reputation as a safe haven asset. When markets are in turmoil, many investors flock to gold, drawn by its enduring value and role as a hedge against inflation and currency devaluation. Gold is also highly liquid, with a global market that allows for easy buying and selling.

On the other hand, gold doesn't generate income like dividends or interest, and its price can be surprisingly volatile. It can be swayed by everything from geopolitical tensions to changes in currency values. While it may offer protection in uncertain times, gold can underperform during periods of economic stability and growth, where it yields no regular income to investors.

Perceived defensive factor : Medium to high. Gold is a robust defensive asset during crises, though its lack of income and potential volatility make it less appealing when stability returns. See how it compares to bonds .

Defensive shares

Defensive shares, found in sectors like utilities, healthcare, and consumer staples, are the stalwarts of the stock market. These companies produce essential goods and services, ensuring consistent demand even when the economy falters. As a result, these stocks tend to be less volatile and often come with the added bonus of reliable dividends , potentially providing a steady passive income stream .

But, while they often hold up well in bear markets , defensive shares aren’t completely immune to market fluctuations. They also tend to underperform in bullish markets, where more cyclical stocks may outshine them. Despite this, their high liquidity and relatively lower risk make them a favoured choice for conservative investors.

Perceived defensive factor : Medium to high. Defensive shares offer a balance of income and stability, though they still carry market risks and may lag in growth-oriented markets.

Property

Property , especially residential real estate, is a favourite among defensive investors looking for tangible assets that generate steady income. Real estate often provides a hedge against inflation, as both property values and rents typically rise over time. The appeal of owning something concrete, combined with the potential for long-term appreciation, makes property an attractive defensive asset – particularly in Australia.

In saying all that, real estate isn’t without its challenges. It’s illiquid, meaning it can take time to buy or sell, and transaction costs can be steep. There’s also market risk: property values can dip in economic downturns, and managing tenants can be time-consuming and costly. Finally, the cost barrier to entry can be enormous (as any Australian will tell you). Despite these drawbacks, property has the potential to deliver solid returns, especially in prime locations.

Perceived defensive factor : Medium to high. Property can offer income and inflation protection, making it a strong defensive asset, but its cost, illiquidity, and management demands pose challenges.

What should I consider if I’m thinking about investing in defensive assets?

When considering an investment in defensive assets, it’s essential to evaluate your financial goals , risk tolerance, and the current market environment. Defensive assets are designed to provide stability during economic downturns. However, they also tend to offer lower returns compared to more aggressive investments like equities.

First, assess your risk tolerance. Defensive assets are popular among conservative investors who prioritise capital preservation over high returns. They can serve as a cushion against market volatility, especially during economic recessions.

Next, consider the time horizon for your investments. If you’re nearing retirement or need access to your funds in the short term, defensive assets may help protect your portfolio from sudden market downturns.

Additionally, keep in mind that while defensive assets are generally stable, they are not completely risk-free. For instance, bonds are subject to interest rate risk, and gold prices can be volatile.

Lastly, think about diversification . Even within defensive assets, spreading your investments across different asset classes – like mixing bonds with defensive stocks – could provide a more balanced approach, enhancing the overall defensiveness of your portfolio.

Always make sure you fully understand what you’re investing in and reach out to a licensed financial adviser if you need tailored advice.

Happy investing!