Howard Marks, the legendary co-founder of Oaktree Capital, once wrote that real success in investing is not beating the market when it rises, but losing less when it falls. That idea has always resonated with me. Markets are unpredictable, and no one can eliminate risk entirely. But if you can protect your portfolio during the worst stretches, the upside usually takes care of itself.
That is where risk management comes in. For everyday investors, protecting your portfolio from big losses means you can stay invested, avoid panic-selling, and let compounding build wealth over decades. Markets will always be unpredictable, and no one can eliminate risk. But you can build guardrails that make losses survivable. If you can protect your portfolio when things go wrong, the compounding takes care of itself over time.
Here are five strategies I use to reduce risk in my stock portfolio.
1. Use Quality as Protection
The spring of 2020 was one of the wildest stretches I have ever seen in markets. The S&P 500 fell more than 30% in just over a month. Oil went negative. Trading halts became routine. Airlines and energy companies were getting crushed, and plenty of smaller, speculative names saw their stock prices cut in half almost overnight.
Quality Holds Up Better
But not everything fell in tandem. Some companies, the kind I consider quality, like Procter & Gamble, Microsoft, and Costco all fell less than the broader market. Their businesses were not immune to Covid related shutdowns. Instead, they were insulated as a result of their wide moats, consistent profitability, and balance sheets strong enough to weather a storm.
Those qualities gave them durability. And when the economy began to recover, operational leverage worked in their favor. Revenues returned faster than costs rose, allowing earnings power to snap back.
Research backs this up. AQR’s Quality Minus Junk study found that companies with strong balance sheets, consistent profitability, and reliable earnings fell less in downturns and compounded more steadily over time. Polen Capital’s work shows the same pattern across decades of business cycles. Quality holds up best when conditions are most difficult, like recessions.
The Trade-Off
This is not to that quality outperforms in every environment. In early 2021, the meme-stock frenzy in GameStop and AMC showed how quickly speculative names can skyrocket. For a few months, owning J&J or Costco did not look exciting compared to a stock doubling in a week. But when reality set in, those quality companies were still compounding. That is the difference.
This is why my discipline is built on quality compounders. They provide resilience when markets turn rough and the staying power to keep building value over time.
2. Pay Attention to Valuation
A great company bought at the wrong price can still be a terrible investment. Cisco is the textbook case. At the peak of the dot-com bubble in 2000, it traded at more than 100 times earnings. The business was dominant and profitable, but the stock price had sprinted so far ahead of fundamentals that when sentiment turned, Cisco’s shares collapsed. Twenty five years later, Cisco still has not fully recovered those highs. That is the risk of ignoring valuation. Overpaying raises the odds of underperformance, or in the case of Cisco, of permanent capital loss.
That is why I focus on valuation alongside quality.
Using Multiples
In 2025, I bought Thermo Fisher Scientific (TMO) for around $410 a share. At the time, the stock traded down to just 17x earnings, far below its 10-year average of 25x. The market was pricing in a storm of bad news: fading COVID-related revenue, a slowdown in biotech funding, and pressure on margins. Lower growth was already baked into the multiple. That reset expectations and reduced my downside risk, even if the near-term environment remained difficult.
Using Valuation Models
Valuation models are also a prudent exercise, but they should not be treated as tools for precise answers. Their real value is in testing assumptions. If a stock is priced as though it will grow 20% annually for the next decade, the question becomes whether that expectation is realistic. The purpose is not to forecast with certainty, but to gauge what the market has already priced in and whether the business has the runway to deliver.
In the case of Thermo Fisher Scientific (TMO), for example, a discounted cash flow (DCF) analysis with relatively conservative inputs still suggested the stock was trading below fair value, highlighting how valuation can tilt the risk/reward balance in an investor’s favor.
Now, valuation does not guarantee safety. Cheap companies can stay cheap, and expensive ones can keep rising. But buying a quality business at a fair price provides a cushion. It lowers the bar the company needs to clear and makes it easier to ride out disappointments.
3. Disciplined Diversification
In 2022, Netflix (NFLX) lost more than 70% of its value at one point. Meta (META) fell over 60%. These were not speculative penny stocks. They were dominant businesses with global reach and massive user bases. Yet being overweight either name was ruinous. Investors who had 20–30% of their portfolio tied up in one stock saw years of compounding disappear in months. Worse, those kinds of losses make it hard to stay disciplined. It is not easy to watch that much money evaporate without feeling the urge to sell.
That’s why diversification matters even when buying quality names. Traditional advice often points to the 60/40 portfolio — 60% stocks, 40% bonds. That framework has merit, but here I am focused on protecting the stock portion of a portfolio, where reckless concentration can undo years of progress.
ETFs as a Foundation
I build diversification in two ways. ETFs form the foundation of my stock portfolio. They give me broad exposure across markets and sectors I could not replicate with individual picks. iShares Core S&P Small-Cap ETF (IJR), for example, covers profitable small caps, VanEck Semiconductor ETF (SMH) gives me semiconductor exposure without having to guess winners. And core funds like Vanguard Dividend Appreciation Index Fund ETF (VIG) and Invesco NASDAQ 100 ETF (QQQM) provide consistent exposure to the market. These positions do not eliminate drawdowns, but they spread risk across hundreds of companies and soften the blow of any one collapse.
Position Sizing Discipline
Then come individual stocks. This is where I look for alpha, but discipline matters. My new positions are built gradually, usually up to 5% of the portfolio. This typically results in holding 8–12 high conviction names. I do allow winners to run beyond that 5% threshold, but the initial sizing ensures no single stock dominates from the start.
Yes, drawdowns still hurt, but that is expected. What I want to avoid are mistakes, misreads, or unforeseen risks crippling my portfolio. More importantly, this discipline gives me the flexibility to add to high conviction, quality names during downturns (if the thesis remains intact), instead of being paralyzed by losses.
Diversification will not prevent losses, but it does makes them survivable. And that survivability is what allows compounding to continue.
4. Cash as Dry Powder
For more than a decade after the financial crisis, cash was considered dead weight. With interest rates pinned near zero from 2009 onward, holding cash meant sacrificing returns. Every dollar sitting in a savings account or money market fund felt like a missed opportunity, and investors were encouraged to put every cent to work in risk assets just to stay ahead.
Why Cash Matters Now
That is no longer the case. Today, cash earns 4–5% in T-bills or money markets, risk-free. For the first time in my investing life, I do not have to stretch for yield or force investments to make a return. Simply waiting now pays.
But the real value of cash shows up when markets turn ugly. When stocks are falling and fear dominates the headlines, cash becomes invaluable. Instead of feeling pressure to sell, you are prepared to buy when opportunities appear. And history shows this is how fortunes are made, by buying at the scariest moments. I have written about this before, during the market’s reaction to tariff announcements, when many investors believed “this time is different.” That piece reflects exactly why preparation matters.
Building Cash Deliberately
I also think about cash as something to build deliberately. As a bull market stretches and bargains disappear, I let my cash position grow. It does not mean abandoning equities, but it does mean being patient until prices once again reflect opportunity.
Too much cash will slow compounding. But the right amount cushions a portfolio while it sits, and it provides the flexibility to act when markets break. That combination makes cash one of the simplest, most effective risk-management tools available today.
5. Using Covered Calls to Trim Risk
Costco (COST) is one of the best run businesses in the world. Its scale and customer loyalty are almost impossible to replicate. I have written before about the quality of Costco and why it stands out as a company worth owning.
See → Why Costco’s Stock Defies Valuation Logic
In each piece, though, the caveat was the same: its premium valuation. As an owner, that premium meant forward returns were likely to be modest, even though I admired the business.
Why I Turned to Options
Instead of selling outright when Costco ran well beyond my estimate of fair value, I turned to a covered call strategy. Options aren’t for everyone, and there are risks, but here’s what I did.
A covered call means selling a call option against 100 shares you already own. Each time I sold the call, I collected a premium based on the strike price I chose. Since Costco was trading in the $900s, I set my strike at $1,000. If the stock climbed past that level at expiration, I would be forced to sell. The premiums I collected reduced my cost basis and boosted my return. I used this strategy several times before Costco was eventually called away, and so I no longer have a position.
The Benefits and Risks
There are clear benefits of covered calls. These include income from premiums, discipline around trimming positions that have run too far, and some downside cushion. But there are also risks. By selling calls, I effectively capped my upside. Had Costco continued to surge beyond $1,000, I would have missed those gains. And once shares are called away, the next challenge is deciding whether to buy back in or reallocate the cash somewhere else. Neither is always straightforward.
Covered calls are not a primary strategy for me. But they are a tool that I use selectively as a kind of safety valve when a stock I own trades far beyond what I believe it is worth. Used carefully, they give me one more way to control risk without rushing to sell a company I would otherwise be happy to own.
Final Thoughts
The goal of investing is not to avoid risk. That’s impossible. The goal is to manage the risks in a way that keeps you in the game long enough for compounding to work its magic.
For me, that means owning quality companies that can survive downturns and thrive in the recovery. It means paying attention to valuation so expectations can reasonably be met, and diversifying so no single mistake can wreck years of progress. It also means holding some cash so I can act when fear creates opportunity, and using tools like covered calls, carefully, to leverage positions that have run ahead of fair value.
None of these strategies will eliminate drawdowns. But together they make them survivable. And that survivability is what allows compounding to continue. In the end, this is how wealth is built.
Disclosure: I have a long equity position in META Inc. (META), Thermo Fischer Inc. (TMO), iShares Core S&P Small-Cap ETF (IJR), VanEck Semiconductor ETF (SMH), Vanguard Dividend Appreciation Index Fund ETF (VIG), and Invesco NASDAQ 100 ETF (QQQM).
🠔
Want more? Check out other articles
🠖
- 3 Beaten Down Quality Stocks Worth A Look
- How Warren Buffett’s Letters Shaped My Investment Philosophy
- Disney Stock Under $85: Value Play or Risky Bet?
