With high-flying stocks like Tesla and Twitter running into turbulence, worries about a China implosion, the Ukraine fiasco, and political stalemate in Washington, it might be a good time to schedule a stress test.
I mean for your portfolio.
Seriously, just how would your portfolio perform under the pressure of a market sell off of 20% or interest rates spiking?
Diversification into more liquid and conservative investments is always a good idea but the “usual suspects” might not get the job done. Municipal bonds? Fitch expects to downgrade dozens if not hundreds of issuers as municipal finances worsen. How about steady eddy dividend paying blue chip stocks? Have you already forgotten that they got their heads handed to them just a few years ago during the global financial crisis?
Remember, the unexpected can and will happen. The trick is not only preventing the unexpected to hammer your portfolio but instead serve as a springboard for big gains.
Don’t hide from uncertainty, expect and embrace it and it will make you stronger. This is the theme of Nassim Nicholas Taleb’s new book, Antifragile: Things That Gain from Disorder. Here is one way Taleb aptly puts it:
“It’s far easier to figure out if something is fragile than to predict the occurrence of probability of it being fragile. Anything that has more upside that downside from random events is what is anti-fragile; the reverse is fragile.”
How can we apply this to out portfolios? First, don’t let big selloffs ruin your nest egg and, then, be ready to turn a downturn to your advantage.
#1 Rule – Trailing Stop Loss
We have all been there. You buy a stock or fund and it appreciates in value rapidly. Then it stumbles and begins to decline. What should you do? Buy more, let it ride, or sell?
Save yourself a lot of pain and agony by following a simple rule. If a position ever falls more than 20% from its high, sell it immediately and reassess the situation.
Some may counter that this 20% rule is a bit arbitrary but no doubt a 20% decline from a high is about as much as most investors can handle. This sort of decline also indicates that the fundamentals have broken down. More risk adverse investors may want to have a tighter stop loss policy set at 15%.
Shift to a Value Strategy
Capital is rotating into value stocks for two simple and powerful reasons: value stocks have lower downside risk and higher upside potential.
My Value Bounce investing formula is so simple and easy to follow that you don’t even need a ninth grade education to score big gains in a short time. We all learned the basics as school children bouncing the ball at recess.
This explains why all open Value Bounce recommendations are currently in the black with two stocks surging over 30% in the last month.
And late last year, I noticed that Royal Gold (NASDAQ:RGLD) was trading at levels way below the value of its gold and silver reserves and sent out a buy alert to members. The result: a 47.9% “value bounce” in less than four months.
Taking a longer view of markets just makes the value case even stronger. Royce Funds Research, for example, did a study going back to 1978, which determined that these deep value stocks outperformed growth stocks by a 3-to-1 margin over that span. A report in Kiplinger’s determined that these deep value stocks have outperformed the market for the last 81 years.
Use Inverse ETFs to Hedge
While it usually doesn’t pay to make calls on the direction of markets, you should be aware that there are many inverse ETFs that move opposite markets. For example, if you had a very strong belief that emerging markets were significantly overvalued but for tax reasons didn’t want to sell, you could hedge your positions with a dash of (EUM) which moves opposite the MSCI Emerging Market index. There are inverse ETFs out there on a wide range of assets from oil to gold to U.S. Treasury bonds.
The point is not to go overboard with this strategy but even a small allocation can cushion your portfolio from heavy losses.
Cash is Priceless in a Crisis
Many investors have a hard time holding meaningful amounts of cash in their portfolio.
Cash has to be put to work for a portfolio to grow but if you are 100% invested in your equity portfolio how can you take advantage when the market hands you “fire sale prices? Think of the gains if you had the cash and courage to invest in blue chips at the peak of the global financial crisis when stocks were cheap as dirt.
Yes, taking some of these measures will be a drag on your portfolio returns in a major bull market but as I always say, better safe than sorry.
