How to Cut Your Risk and Maximize Your Gains in Today’s Market
Earlier this year, I advised investors against reacting to the daily headlines whether they deal with “the election crisis,” “the coronavirus crisis” or some other crisis du jour.
This is tough for some folks, especially those new to the investing game.
Every day they see changing interest rates, commodity prices, currency values, economic indicators, political events and stock market valuations.
As a result, they often feel a strong compulsion to “do something.” But what?
Unless you have strong contrarian instincts – and the willpower to follow through on them – the best answer is to sit on your hands.
Success comes not from timing the market but from time in the market.
True, every portfolio needs to be tweaked occasionally.
But it is a mistake to find yourself in a constant state of reaction to the day’s events, news that is guaranteed to seem less dramatic in hindsight.
While bid/ask spreads and trading commissions have come down dramatically in recent years – all the way to zero in some cases – there are still two strong arguments against hyperactivity in your brokerage account.
The first is short-term capital gains taxes.
Take profits outside of your qualified retirement plans in less than 12 months and you will be hit not with the maximum 20% long-term rate but a rate pegged to your ordinary income, which may be as high as 37%.
And that’s before tacking on any state taxes.
Regret is the second argument against a continual flurry of activity.
How many millions of investors have owned great stocks but sold them too quickly, either because they were afraid the market would tank or the stock itself would?
Yes, we witnessed the fastest market crash and subsequent recovery in history. That has provided countless opportunities to sell too soon.
But it’s important to remember that a share of stock is not just an electronic blip or a price on your statement. It’s a fractional interest in a business.
If that business is thriving – sales are up, market share is increasing, profits are rising – you want to hang in there long enough to benefit from the growth of the company.
In the 1960s, investors held a stock an average of eight years. Today it’s less than four months.
Unless you’re a dedicated short-term trader, that’s not enough time to maximize your returns.
Of course, you can’t know with certainty how long an economic expansion will last… or when a bull market will end… or where the stocks you own will peak.
Nor do you need to guess.
Rather, you can capitalize on uncertainty by hedging your bets and protecting your stock positions.
Hedge by making sure a significant portion of your money is invested outside equities.
Aside from the home you own and the cash you hold, good alternatives are real estate investment trusts (REITs), high-grade bonds, high-yield bonds and Treasury Inflation-Protected Securities (TIPS), all parts of our Oxford asset allocation model.
Within your stock portfolio, you should also run trailing stops. These allow you to cut any losses short and let your profits run.
Ignore this step and – in the next severe correction or bear market – your unrealized gains will slip through your fingers and small losses may become unacceptable losses.
The alternative – trying to outguess the market – may sound good in theory but doesn’t work in practice.
(Although there are plenty of stock market gurus who make a good living trying – and failing – to do just that.)
By diversifying your portfolio and running trailing stops, you are managing risk, not running from it.
That’s what successful investing is all about.
About Alexander Green
Alexander Green is the Chief Investment Strategist of The Oxford Club, the world’s largest financial fellowship. For 16 years, Alex worked as an investment advisor, research analyst and portfolio manager on Wall Street. After developing his extensive knowledge and achieving financial independence, he retired at the age of 43.
Since then, he has been living “the second half of his life.” He runs The Oxford Communiqué, one of the most highly regarded publications in the industry. He also operates three fast-paced trading services: The Momentum Alert, The Insider Alert and Oxford Microcap Trader. In addition, he writes for Liberty Through Wealth, a free daily e-letter focused on financial freedom.
Alex is also the author of four New York Times bestselling books: The Gone Fishin’ Portfolio: Get Wise, Get Wealthy… and Get On With Your Life; The Secret of Shelter Island: Money and What Matters; Beyond Wealth: The Road Map to a Rich Life; and An Embarrassment of Riches: Tapping Into the World’s Greatest Legacy of Wealth.