A New Shield for Your Portfolio

When the markets get dicey, stock investors start running for cover. One traditional rule of thumb is that to protect yourself from market downturns, you should buy value stocks. But that hasn't worked very well lately. Meanwhile, something that rule of thumb also advises against doing during rough patches -- buying growth stocks -- has worked out pretty well.

Wild stock market gyrations always give shareholders a mix of fear and greed. From one perspective, the markets are still very close to the highs they set earlier this year, and you want to eke out every last penny of profit before giving in to what some consider is a looming bear market. Yet there's always the fear that by hanging onto your shares until the bitter end, you'll overstay your welcome. And when big drops happen, you start thinking your fears are justified.

Value: the traditional safe haven
Historically, investors have sought refuge in value stocks. With less lofty valuations and more stable business models, value stocks have tended to hold their own more successfully than their growth-stock counterparts during bear markets. Traditional defensive plays like drug companies, tobacco, and food and beverage stocks have relatively constant demand even when the economy starts doing badly.

Value stocks have been incredibly popular during the past several years, though. As represented by the iShares Russell 1000 Value Index ETF (IWD), value stocks have risen 14.3% per year annually in the past five years, while the corresponding iShares Russell 1000 Growth Index ETF (IWF) has a more modest 11.5% annual return.

Growth: the up-and-comer
But that trend has started to change. So far this year, growth stocks are up nearly 12%, while value stocks are actually down almost 1%. Growth stocks have also done well since July's big market drop. A quick look at some representative value and growth stocks tells the story.

Value stocks

Stock	Year-to-date return
Citigroup (NYSE: C)	(41.8%)
Morgan Stanley (NYSE: MS)	(24.7%)
Chevron (NYSE: CVX)	30.2%
Kraft Foods (NYSE: KFT)	(2.6%)

Growth stocks

Stock	Year-to-date return
Apple (Nasdaq: AAPL)	126.1%
Google (Nasdaq: GOOG)	50.7%
Intel (Nasdaq: INTC)	36.7%

Source: Morningstar. As of Nov. 30.

As you can see, much of value's bad fortune in recent months has come from financial stocks. Financials make up nearly 30% of the value index, and the mortgage crisis has hammered them hard. Even continuing strong performance from energy stocks hasn't been enough to offset those losses.

Meanwhile, growth has benefited from strong performance in technology, which makes up more than a quarter of the index. Tech stocks have found buyers in recent months, turning around their rather lackluster performance since the 2000 bear market began.

It makes sense that value stocks are taking a break in the current downturn. One reason that value stocks traditionally do well in bear markets is that they're usually undervalued compared with their growth counterparts. But as value stocks reached lofty valuations, there haven't been many value bargains to be found -- and conversely, more analysts are looking to stocks traditionally included in the growth category for attractive valuations.

How to protect yourself
While rules of thumb can be helpful, it's important to realize that they won't always hold true in particular situations. You have to consider not only general economic principles but also the prevailing market conditions. What makes sense in one case just won't work in another.

In general, the best way to keep your balance in a down market is to stay well-diversified. Sometimes value will do better than growth, and other times, growth will do better than value. Owning some of both keeps you from having to guess which will do better -- and may keep you from making a costly mistake if a popular rule of thumb turns out to be wrong.

For more on defensive investing, learn about:

• Whether the U.S. economy is headed over the cliff.
• The coming market crash.
• Why foreign stocks have performed so well in recent years.