As an investor, you know very well that your portfolio’s position can drop in market value on any given day of the week without notice. Protecting your portfolio from a drop in market value isn’t easy, but it’s not impossible. You can even do this without selling anything or paying taxes. 

Let’s explore some of the possibilities. 

Borrow On Margin

Many investors with large capital gains borrow some of the increase in value of their holdings from their brokerage account. A stock loan is a profit center for brokerage firms, so they will be happy to assist you in setting up a margin account. Many firms can do this entirely online. Most firms will negotiate the interest charged if you’re a reasonably well-heeled client. A great feature of margin borrowing is that you can claim a tax deduction for interest paid on a loan on your securities. You wouldn’t be able to do this if you bought tax-advantaged investments like municipal bonds. Be aware that the deduction amount is capped based on your net taxable investment income for the year. Any remaining interest expenses get carried over to the following year.

These loans usually require a minimum of $2000 in cash or margin-able securities. Depending on who you borrow from, the equity in the margin account is required to be at least 25% of the total value of the securities and can go up to 50%. Be safe and diversify your assets in your account to avoid getting hit with a margin call, which generally happens when the value of the securities falls below the maintenance margin. If you have $10,000 in your margin account and that account requires a 25% maintenance margin, then you’ll need to maintain $2500. The margin maintenance rises proportionally with equity increases, so keep that in mind. 

In any case, borrowing on margin may be more tax-efficient than selling stock and paying long-term capital gains or short-term gains when there is still upside potential in the investment.  

Limit Downside Risks with Collars

Collar options are strategies that can help limit downside risk, but it does, however, have the effect of limiting profits on the upside. Therefore, you wouldn’t want to use this strategy if you’re trying to make huge gains, but rather when the market is bearish, and you want to protect your investments. 

If you have large unrealized gains in security, you may sell an out-of-the-money call option and use the proceeds to purchase a put option to limit the potential loss from a market sell-off. 

For example, if you own 100 shares of a company’s stock at $45 and the price has risen dramatically to $100, and you want to protect those gains, you might buy a put with a strike price much higher than your costs. This is completely discretional but for the sake of an example, let’s say we sell the $110 call option out six months for $5 and buy the $90 put that expires in six months for a cost of $5. The investor has no cash expense other than the commissions on the options. The sale of the call option pays for the purchase of the puts. These prices are quoted in the options market for 100 share lots. You won’t lose or gain anything if you’re within the collar when expiration arrives. 

An added benefit is that collar options hedge against a downturn in the market without triggering a taxable event. As long as you don’t sell your stock to the call or put holder, you won’t have to pay taxes on the profit. You can generally buy or sell the options you sold or bought before expiration if you change your mind or circumstances warrant it.

Hedge Your Bets with Inverse ETFs

Successful investing takes a great deal of timing and understanding of the market conditions. At the same time, it can get tricky to find securities that will yield good returns in a bear market. Investing in an inverse ETF can help hedge your bets against a market downturn since these are specifically designed to profit from broad market indices like the Russell 2000 or the Nasdaq 100.  

You can also find one that focuses more narrowly on a specific sector such as biotech, energy, or financials. For example, if you want to bet against a declining S&P 500, look into ProShares Short S&P 500 (SH) or check out ProShares Short Dow 30 (DOG), which hedges against the Dow Jones Industrial Average. Make sure you have an exit plan, though, because you’re betting against the stock market, which always recovers, so you’ll want to sell the inverse ETF when that happens.  

Invest in Municipal Bonds

Municipal bonds are debt securities issued by cities, states, counties, and other governments to raise money for daily operations and projects like sewer systems, highways, or building schools. When you buy municipal bonds, you’re lending money to the bond issuer in exchange for interest payments, usually on a semi-annual basis, along with the principal amount returned. Investing in municipal bonds is a great way to add some protection to your portfolio when the market drops. It’s possible because they are not correlated to the market.  

One of the critical benefits of municipal bonds is that the interest is generally exempt from federal income tax. In some cases, state and local taxes are exempt, but only if you reside in the state where the bond was issued. If you’re looking to preserve your wealth while enjoying a steady stream of income while enjoying tax benefits, this would be a significant investment.

Diversify With Gold

Gold investors are usually the happiest when the stock market crashes. It’s because there is a negative correlation between