134: Portfolio Management: How to Protect Your Stock Portfolio

LindaPodcast1Learn 2 ways you can make money during a stock and/or bond market decline: inverse ETFs and Puts.

Listener question:

Hi Linda,

I’ve been listening to you and I’m concerned about the stock and bond markets. How do you recommend I protect my account? Christy

There are 2 ways you can make money during a stock and/or bond market decline: Inverse ETF’s and Puts.

Inverse ETF’s are Exchange Traded Funds that make money (go up) when the market declines. You are buying futures, and this was not possible over a decade ago. It was something only professional traders could do. You have to be very careful, it’s not something to buy and hold. You want to trade and be in and out of these. They can move against you quickly.

There are about 75 inverse ETF’s providing protection on US equites, government and corporate debt, foreign markets and commodities.

One of the most popular inverse ETFs is ProShares Short S & P 500 (SH). If the market dropped about 10%, it would go up about 8%. At the time of this recording, the S & P is up 1% and SH is down 1.9%.

The other thing you can do is buy puts. Puts are a bet on the direction of the market. If you think a stock or index is going to decline, you can buy a put, where you risk a limited amount for a specified period of time, typically 30 days. They are based on time and price. If a stock goes below a specified price you are “in the money”. Part of the price is determined by the time you are holding the option. As it gets closer to expiration, it loses value. You limit your risk to the amount invested. Can expire worthless.

Both of these are difficult to get right because you have to know when to buy and when to sell. Timing in a bear market is tricky. Markets tend to go down a lot faster than they go up.

They also tend to rebound sharply, so it’s moving in the opposite direction and can cause large changes in the price if you hold too long. The timing is very tricky on either strategy so be very careful when trying to implement them.

The other thing you can do is simply wait in cash. By waiting in cash you can wait for a downturn and dollar cost average (that is invest in regular intervals) to buy back in. That will give you a lower average cost basis and allow you to get in at a low price.

Bernard Baruch used to say, “Buy when there is blood running in the streets.”

I say, “Buy when the news is at it’s gloomiest. When no one wants to buy, that is the time you’ll get the best price.”

With the stock market in its 7th year of expansion, it’s reasonable to take measures against a market decline. Use these strategies judiciously – again, I caution you NOT to buy and hold or worse, buy and forget you own an inverse ETF. They are volatile and can move against you quite easily.

Personally, I’m sitting out of stocks and investing in alternatives that are not correlated with the stock market. That way, I can take my time and wait for the right opportunity to get back in. Cycles tell us another big tsunami could be headed our way, so IMO it’s a good time to sit out.

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