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Ways to Protect Your Investments on Huge Market Drops and Systemic Loss DISCLAIMER - I am not a Financial Advisor and do not work for any Brokerage Firm. The opinions given are of my own and are not to be used as professional advice. These are my findings and can hopefully help you to make informed decisions on investing. Consult a Broker or Lawyer before making any investment. We hear a lot of brokers and investment professionals promoting diversification as a method to prevent loss in the stock market. While being balanced has some logic to it and does prevent some losses, what happens when the market has systemic loss? This is when all the market goes down. Your retail stocks go down at the same time utilities, banking, and high techs go down. You watch as all other classes go down like we had happen in early 2022. During that time, I lost 30% of my stock market portfolio value. When the whole market drops 20 to 40% in a short span of time, diversification does not lessen the blow. In 2022, not only did we lose money on stocks and ETFs, but bonds also suffered losses. Today I am going to go over a way I have learned to protect against systemic loss. Before that, we will discuss some other methods to prevent losses. One of the reasons many people refuse to invest in the stock market is the fear of loss. It is real, and I understand your feelings. Anyone who says that big market drops do not bother them either has very little in the market or the money is of little significance to them. For years, I have recommended riding out the market bumps with the ebbs and flows. And for all the bull markets we have seen, they are always followed in time by a bear market. If you are unfamiliar with those terms, a bull market means stocks are going up the majority of the time, whereas a bear market is when the stocks are dropping most of the time. Trying to time the market is very difficult. I tried a few times and found that most of the time I was either late in selling or waited too long after the bottom to buy back in. Typically when the market rebounds, it is by 1,000 to 2,000 points. So on those days, you want to be invested to gain the most traction and good returns. I have tried to take the buy and hold strategy the last few years, and have done well. However, a huge drop in the market can throw a wrench in your plans when you reach your retirement years like me. The reality is that a huge loss would be very difficult in which to recover. A young person can lose a lot and still come out in the long term. So this article is geared toward you that are in your 50s or older. However, some of the strategies might be wise even for the younger audience due to the current market. Below is the method I have for years recommended. This article from Fidelity came out in June urging people to stay the course even in the choppy markets. Fidelity shows that people churning money in and out on a whim rarely break even with the people who continue to buy when everyone else is panicking. Here is an excerpt from that Fidelity article: Stick with your plan, even when markets look unfriendly When the value of your investments falls, it's only human to want to run for shelter. But the best investors don’t. Instead, they maintain an allocation to stocks they can live within good markets and bad. The financial crisis of late 2008 and early 2009 when stocks dropped nearly 50% might have seemed a good time to run for safety in cash. But a Fidelity study of 1.5 million workplace savers found that those who stayed invested in the stock market during that time were far better off than those who headed for the sidelines. In the decade following the start of the crisis in June 2008, those who stayed invested saw their account balances—which reflected the impact of their investment choices and contributions—grow 147%. That's twice the average 74% return for those who fled stocks during the fourth quarter of 2008 or the first quarter of 2009. While most investors did not make any changes during the market downturn, those who did make a fateful decision with a lasting impact. More than 25% of those who sold out of stocks never got back into the market and missed the gains that followed. If you get anxious when the stock market drops, remember that’s a normal response to volatility. It’s important to stick with your long-term investment mix and to have enough growth potential to achieve your goals. If you can’t tolerate the ups and downs of your portfolio, consider a less volatile mix of investments that you can stick with. So the old, proven, continual purchasing whether the market is up or down appears to be a good way to go. The term is dollar-cost averaging. If you buy when the stock price is high and sell when it is low guarantees a loss. But if you purchase while the price is down, the average price per share drops. This hopefully gives you the ability to make up quickly for earlier losses. With that being said, let’s look at where we are here in November of 2023. I think a little insurance might be wise at this time. Normally when the bellwether stocks go down, the bonds kick in to offset some of the losses. Will a bull market return? A bull market is likely to return, as it typically has. But when? Well, every period is different and there can be no guarantees. We have had about 1000 point up market since mid October. I personally at my advanced age have 30% of my investments currently in Cash or bonds, with a large segment weekly going to I-Bonds. This is probably too much in stocks to be honest. After bonds and CDs, the next thing to invest in is the overall stock market indexes. ETFs like: ITOT VTI SCHB VOO SPY etc. Having some of your money in good quality Growth Mutual Funds is always a good conservative investment. And then be sure you have some investments across all the 11 sectors of the market. Mutual funds help to give you a lot of diversification. I discussed those 11 sectors in my article on investing with ETFs. When you diversify, that helps you to offset bad sectors with those that are great. All of the time some sectors are outperforming others. This year the oil and gas business has been up again this year as well as the high tech stocks. Health care is another sector performing well in the current market. If you are diversified, and have a lot of money in full market stock indexes, does that guarantee you no loss in a huge drop in the market? No, it does not. That is why I am so cash conscious right now. When you look at the news, with problems all over the world, Russia invading Ukraine, and the leaders in Washington out of step in almost every area, what is the likelihood that we will go from the current 33,900 NYSE average to 36,000? It might happen, but with all the gloomy news, we may be ready for another huge drop like in 2008 or 1972 or worse of all, 1929. I wasn’t around for the great depression, but I remember both 2008 and 1972, and both were hard to bear. I hate to be a bearer of bad news, but realistically, we could go from 33,800 to 25,000 very easily, and a drop to 15,000 would not be impossible. That would mean a 50% or greater loss in your average stock holdings. Can you withstand a loss of 50%? I am too old to recover from such a huge loss. If you are in your 20’s, you probably could. But would it not be smarter to have some insurance against such a catastrophic loss? Warren Buffet, probably the world’s most respected investor, has 2 rules that he follows. Rule Number 1 is to never lose any money. Rule Number 2 is to always remember Rule Number 1. 😊 In the past two years, I have read 4 of Richard Kiyosaki’s books in the Rich Dad, Poor Dad series. Last year, I watched one of his online seminars, and in that presentation, he said he does all he can to NEVER lose money. (like Warren Buffett.) Now to never lose money and invest is pretty much impossible, but there are ways to hedge your losses. Mr. Kiyosaki introduced me to several, and one of them I want to cover today. This method is like having an insurance policy. How this is done is by issuing a STOP LOSS sell on your stocks and ETFs. Mutual funds and Nasdaq stocks are not eligible for this, but the ETFs and Stocks with 1 or more shares held are. If you have never heard of a stop loss sale, let me explain it a bit. A stop loss LIMIT order allows you to specify the price you will receive on the stock or ETF when you set the value to trigger the sale. Now, remember that a down market generated this sale. Is it possible that if you specify a LIMIT, you will receive it? Possibly, but unlikely. So, your order might never process. Now if you do not specify a LIMIT on the stop loss order, then it probably will be filled, but not at the price that you specified to submit the sell order. You would receive the current market price if there is a buyer. So if you specify the stop loss to be issued at $40 for example, probably the best you could hope for would be $39 or a bit over. And someone has to agree to buy it. For every sell order, someone has to buy. So if it is a huge market drop, your $40 stop loss might wind up sold for $35 or not at all. So keep in mind, that a STOP LOSS order is not a contract for the price you specified. Just a request to sell at the current market price. What I did this past week was I went into my holdings at Fidelity and Schwab, and any with a substantial balance on them, I clicked on the SELL tab. From there, I choose STOP or STOP LOSS (depends on the broker), and you key in the price you want to trigger the sale. As I mentioned earlier, I buy all my stocks and ETFs to hold long-term, so I do not want them to sell on a minor bounce in the market. Richard Kiyosaki suggested using 80% of the current value which is what I used. So on a $50 stock price, if it goes to $40, it will trigger the sale. Now of course this does mean I would lose 20% of the value of the security, but a 20% loss is so much less than a potential 50 to 80% loss. I do not use Stop Limit orders, just Stop orders. So when the price hits the specified price it triggers a sale at market value. You may not get that price but it should be close. On risky investments, I set the stop loss at 92% of the current price and review them monthly for gains and move the price up. On what I consider good investments paying solid dividends, I set the stop loss at 85% to prevent unneeded sales in market daily fluctuations in price. At Fidelity, I chose a GTC order meaning Good until closed or canceled. I did the same at Schwab, but their GTC orders are only good for 60 days. So in 60 days, I will have to rekey those. Of my 80 or so holdings, I am only entering 45 to sell with Stop Loss orders . I may bump those up in time, but the big holdings are what concern me. I think Fidelity is now limiting the GTC orders to 90 days so they are not forever also. I found a great video on Fidelity explaining how to understand and place stop-loss orders. Watch it here: Fidelity Article on How to Enter Stop Loss Orders Should you consider a STOP LOSS order for your larger holdings? If you consider the danger of the current market, I do think it is worthy of consideration. In life, I have found that you normally don’t need insurance if you have it. So, if you key in some stop loss orders and never use them, it is just insurance. BUT, if the market takes a huge downturn, and it could happen, you will eliminate some of your loss. Think about it and read some other authors on the topic and discuss it with your broker. Since we no longer pay commissions to buy and sell Stocks or ETFs, we can simply repurchase the sold items if it was done in just a market shakedown. But if a catastrophic drop, I think you will be glad you did sell. I want to point out that all my investments are in ROTH IRAs so I do not have to consider the short term or long term capital gains. Be aware that in a non-Retirement account, the capital gains may cause you some real tax problems. List of All Minimalism Articles List of All Investment Articles Internet Direct Laptops
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David ParhamChristian Minimalist and Investor. God guides and helps me everyday. Archives
May 2024
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