What is downside protection?

Downside protection, often called a portfolio hedge, is a general term for investments and other agreements which pay off in market and portfolio declines. Common forms include ‘put options’ and futures contracts which require special expertise and trading permissions.

Downside protection can limit potential losses, thus reducing the overall risk of a portfolio even while staying invested for potential growth.

The cost of downside protection is a drag on a portfolio’s performance, compared to an unprotected portfolio. At the same time downside protection can sometimes lead to improved risk-adjusted returns as compared to buy-and-hold without protection, if protection proceeds are reinvested at lower prices in a portfolio which is growing over the long term.