“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”
– Warren Buffett
Stock Market Crash 2015 – Should you be scared?
2015 has been an interesting year for stock investors. 2015 started out with the S&P 500 opening at 2058.9. From there the index has fluctuated between +3.8% and -4.1% most of the year. When investors are accustomed to getting 6 years in a row of positive gains, it is hard to imagine what a down year looks like. In the past week the S&P 500 is down about 10% as of this writing. Is there more ahead? Should you be scared?
Maybe. But it really depends on what you are invested in and how it is structured. If this recent 10% drop is causing you to lose sleep, then you need help.
Here are 9 tips for helping you bring your portfolio to your sleeping point.
1. Eliminate leverage in your portfolio
Many investors use leverage without understanding how it works. While this is an amazing tool for the intelligent investor, it can also be dangerous for investors who don’t understand the risks. If you have a portfolio of $100,000 and it is using 100% leverage, i.e. you own $200,000 in stocks, then you have leverage of 2:1. So for every 1% that your investments rise, your portfolio will rise 2%.
Great idea right? Who wouldn’t like that?
The problem is when the investments drop in value. When your investments drop 1%, your portfolio drops 2% using the same leverage. That’s not fun.
The amount of leverage currently being used in the stock market is excessive at the moment. Don’t get greedy. Now is not the time to take risks. Remove your leverage and maybe consider keeping some cash for future opportunities.
2. Cash is a position
Most people feel that their portfolio needs to be 100% invested into something. Or in the case above by using margin, more than 100% invested. These investors don’t put any consideration into having cash in their portfolio and why that is important. Then when the market sells off, they try to sell their positions. Wouldn’t it be more prudent to sell positions when the market is higher and have cash available for when the market sells off?
Cash is a position too. If you had 100% of your portfolio in cash going into 2008, how happy would you be in March of 2009 to start investing that cash into investments at a huge discount?
“I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime.” – Jim Rogers
This quote is from Jim Rogers about how he waits for opportunities so obviously one-sided, that he doesn’t have to force the investment. He just waits with his cash and invests it when the opportunity is obvious.
Think of cash as a position that works well with deflation. When the prices of assets, goods and services are dropping your cash is worth more in comparison. Deflation has not been a part of the US economy for over 70 years, but it does exist and it is important to understand how it works.
3. Don’t put all your eggs in one basket
If you want to sleep well at night, don’t have all your net worth tied up in one investment. Whether this is your house, your company stock, or some other investment. Diversification is important from the standpoint of making sure that one investment cannot destroy your net worth.
Many people have a majority of their net worth tied up in their company stock. There is nothing wrong with this especially when they are controlling the company. Who better to know the fate of the company than the person running it. However, there are ways to diversify out of some of this holding to invest in other areas. While many people think this means investing in areas that are dissimilar to the concentrated position, I would disagree. People should invest in what they know best. If you are an expert on real estate, then you should not be investing in tech companies. Focus on what you know best.
Other people have most of their net worth tied up in their home. This is where you live, so it is important to maintain it well and hopefully it grows in value. It is hard to argue with investing in your home, however, your home is not an investment. I wrote about this a few weeks ago, in my post, Should You Buy or Rent Your Home? Don’t assume it is an investment. It is a personal expense. Treat it as such.
If you own 30%+ in one stock, and you don’t work there, you should revisit why you have such a large position in one investment. Think about what would happen if that investment went to zero. How would that make you feel? If the answer is “horrible” then you should keep your positions sizes to a point where you can sleep at night.
4. Invest in quality
Inexperienced investors typically invest in low-quality stocks or bonds because they read some article or blog post about how the company is the next Facebook or Microsoft. Don’t do it. The best and brightest minds in the world come to work on Wall Street because that is where the money is. Ask yourself this question. “Am I equip to compete against the best and brightest minds in the world?
If the answer is no, then you should consider investing in other ways. Find high-quality companies with strong balance sheets and a good track record of growth. or just invest in an index. Alternatively, you can find and professional financial advisor who can help manage your portfolio. This can help remove the stress and help you sleep at night.
5. Know your investments
“Never invest in any idea that you cannot illustrate with a crayon.” – Peter Lynch
I find this quote to be the most relevant with inexperienced investors. I frequently get asked about stocks that I have never heard of and the only reasons they are brought up is because of some article the person read. If you decide to only invest in investments that you can explain with a crayon, you will be much better off. This is similar to the above point of investing in quality. Warren Buffett also takes this approach when he stated that he won’t invest in anything he cannot understand. Take some advice from the best and brightest.
6. Don’t chase performance
There are many ways to invest. Some people are growth investors, some are value investors, and some are momentum investors. There are countless ways to invest your hard-earned money. The worst way to invest is to look at the best performing investments and put your money there without knowing more than the performance numbers.
Actually, this is the path many employees take with their 401k plan. They look at the performance numbers and pick the best performer. Frequently this is the last time they look at the funds until they change jobs. This is a bad way to invest your hard-earned money. Don’t do this. Actually, there have been some studies that suggest that the worst performers of one year tend to be the best performers the following year. I am not suggesting you do this, but the point is that you should not base your investment decisions on performance.
7. “Know when to hold em, know when to fold em”
If you have ever been to a casino, you know how it works. If you are on a good run and you are making money, you never want to stop. You keep pushing for another bet, then another, then another, then you lose. But that was just one loss, so you try again, and again, and again. Now you have lost money for the day. What happened? You were making money, now you have lost it.
This is an emotional response to gambling that some people have a hard time controlling. Investing is much the same way. Investors invest in a stock, then it goes down 20%. But they were trained to think about “buy and hold” investing, so they say “it will come back”. And they keep holding it. now it is down 50%. Well, they can’t sell it now, that would be a huge loss, so they keep holding it. This is a hard pattern to break. It is also why bear markets are so hard to make money for investors.
If you bought mining stocks in 2011 and are still holding them, I have a joke for you. What do you call a mining stock that is down 90%?
Answer: it is a stock that was down 80% but then lost 50%.
Think about that for a moment. if you waited for a stock to drop 80% then invested in it, then it drops 50% more. That hurts. If you want to learn more about fear and greed and how it affects your investments, I wrote about it here, How Fear and Greed Can Affect Your Investing.
Do the smart thing, limit your losses, and let your winners run.
8. Dollar Cost Averaging (DCA)
Dollar Cost Averaging (DCA) is a great investment strategy for investors who have a long period of time to wait. This means that they can invest a certain amount each money into investments that they can hold for years. This works especially well when the market is declining. How do you know when the market has hit is low? You don’t. You can only know this much later after it has gone up and it is apparent to everyone.
Don’t try to pick the bottom of a market sell-off. try to find a good price and start investing in multiple tranches. While you may not pick the bottom, overall your cost basis will be lower. it is an averaging approach that works well in both up and down markets.
9. Buy Low, Sell High
This phrase is as old as Wall Street itself. This is essentially what you want out of any investment you make. Buy it at a low price and sell it at a higher price. It sounds easy enough, but in reality, it is much harder to put into practice. What makes stocks expensive and what makes them cheap? Unless you are a savvy investor, you might not know. If that is the case, then you might want to seek professional advice.
Trying to figure out the valuation of investments is why Wall Street professionals get paid a lot of money. It is both an art and a science.
Obviously, no one can know the future, but if you are an active investor, you know when certain investments are expensive and when they are cheap. Why not sell some positions when they are expensive and buy them when they are cheap.
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About Innovative Advisory Group: Innovative Advisory Group, LLC (IAG), an independent Registered Investment Advisory Firm, is bringing innovation to the wealth management industry by combining both traditional and alternative investments. IAG is unique in that they have an extensive understanding of the regulatory and financial considerations involved with alternative investments held in self-directed IRAs and other retirement accounts. IAG advises clients on traditional investments, such as stocks, bonds, and mutual funds, as well as advising clients on alternative investments. IAG has a value-oriented approach to investing, which integrates specialized investment experience with extensive resources.
For more information, you can visit innovativewealth.com
About the author: Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group. His roles at IAG are co-chair of the Investment Committee and Head of the Traditional Investment Risk Management Group. His background and areas of focus are portfolio management and investment analysis in both the traditional and alternative investment markets. He received a BA degree in Economics from Trinity College in Hartford, CT.