Despite a cloud of gloom and uncertainty hanging over global markets this year, many of the world’s major stock markets have moved up. And that means that there’s no better time to take stock and check that you’re doing what you should to protect your portfolio, just in case 2018 is less kind.
2017 has been good for stocks
The S&P and the MSCI All Country World Index are both up around 20 percent, and the MSCI Asia ex Japan Index is up more than 35 percent.
After a relatively good run, it’s easy to think that next year will be more of the same… and it certainly could be. But this status quo bias is the enemy of portfolio performance. Investing is like driving: It’s best to be defensive. So here are six steps you should take to ensure that you’re doing what you should to protect your portfolio and you’re not caught off guard if 2018 is a bit trickier.
1. Keep some cash on hand
You’d be smart to have more cash in your portfolio. Yes, it doesn’t pay much, its value erodes over time (due to inflation), and if you lose it (or put it through the washing machine), it’s gone forever.
Holding cash is one of the easiest ways to hedge your portfolio. Hedging helps reduce investment losses when your investment strategy doesn’t work out as planned.
Plus, having some cash on hand let’s you take advantage of any great investment opportunities that may come up. It lets you pick up “money lying in the corner.”
So protect your portfolio by taking some profits off the table to raise some cash.
2. Stick to your stop-loss levels
No one likes to admit defeat. But in investing, it’s important to have a disciplined approach to selling your bad positions and losing the battle. Otherwise, you risk losing the war when a few bad stocks wipe you out altogether.
Every investor has bought a share that’s gone down – an idea that seemed good at the time but is now down 10 percent, 30 percent, 50 percent or more. You might tell yourself a loss isn’t a loss until you sell. And (you tell yourself), if you sell now, you’ll miss the rebound that will make up for everything.
But the key to not losing money isn’t to wait for the rebound – because it often doesn’t come, ever. The key to not losing money is to sell before you feel the need to wait for a rebound.
The best way to do this is to use a trailing stop.
Here’s an example of how it works: if you bought a stock at US$2.00, you might set your trailing stop at 20 percent below that level, or US$1.60. In this case, as long as you stick to your trailing stop, you’ll protect yourself against far greater losses.
On the other hand, let’s say that same stock climbs US$2.20. As the shares rose, you would continually adjust your trailing loss level to 20 percent below the market price. At $2.20, your sell level would be US$1.76. If the shares rose to US$3.00, your trailing stop would stand at US$2.40.
The important thing is to follow through. If the stock falls to the stop loss level price, sell… no questions asked. And make sure you don’t put a standing market order in at your trailing stop level. You don’t want to tell your broker when you’re going to sell. Make sure that you make it a mental level – not one that you tell your broker.
Remember, you can always re-enter at a later date a position that’s stopped out. But the stop loss is there to force you to take risk (and further downside) off the table while you take some time to reassess.
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The idea behind diversification is simple. It means putting your eggs in different baskets. That is, spreading your risk across different types of assets, so that a decline in value in any one holding isn’t so bad – because there will likely be other holdings that rise to help balance out the losses.
But diversification goes beyond just holding a number of different assets… what if you have your eggs in different baskets, but the truck that’s carrying your baskets (that is, the entire financial system) wipes out? You need to make sure that your eggs are in different trucks. This involves spreading your wealth across different markets and economies and asset classes.
Think of it this way… investing an entire portfolio in your home market (even if it’s spread across stocks, bonds, gold and cash, for example) is like having eggs in lots of different baskets… but all on the same truck. If the truck crashes, you’re in trouble. Because all of these assets are in the same country, they’re correlated.
Correlation is the relationship between two or more assets. It measures what happens to the price of one asset when the price of a different asset changes. When they are negatively correlated, their prices move in opposite directions. This evens out your overall performance when things get bumpy. But when they’re positively correlated, it can spell disaster for your portfolio.
That’s why, to protect your portfolio, you need to own stocks and bonds in a variety of markets. You should also spread your savings around in bank accounts in different countries. And if you don’t already own precious metals like gold, now is the time. Gold is one of the most effect hedges against market downturns because its price is negatively correlated to stock markets. That is, when markets go down, gold usually goes up.
4. Own gold
History has proven time and again that gold is one of the best ways to hedge your portfolio – that is, to protect it when stock markets everywhere fall. That’s because gold and stock markets are negatively correlated assets.
And unlike paper money, gold is a permanent store of value.
People have used gold as a currency or medium of exchange for thousands of years. Meanwhile, other forms of money – livestock, shells, enormous stones and tulips – have come and gone.
Gold has withstood history and maintained its inherent value. It’s durable, easy to transport, looks the same everywhere, is relatively easy to weigh and grade… it’s the perfect store of value.
Unlike gold, which is finite, the supply of cash is infinite. Every form of paper money (U.S. dollars, euros, yen, etc.) has a potentially unlimited supply. All central banks have to do – and they’ve been doing this madly for years – is to turn on the printing press.
Paper money can be printed and printed until it’s worthless. It’s legal tender backed by nothing more than faith in the government that prints it. Governments can print as much cash as they want.
However, if a government prints too much money, its currency will lose eventually lose value. In a worst-case scenario, a country’s paper money can become worthless. It has happened in France, China and Germany. It happened much more recently in Zimbabwe. And in Venezuela today, the Bolivar is as good as worthless.
But governments can’t print gold. Gold isn’t based on government promises – it’s a real asset that holds real value. That is why gold is an attractive storage of wealth and it can help you protect your portfolio.
In short, gold is insurance against financial calamity.
These four measures won’t protect your portfolio from all the bad things that markets can do… but they’re a start.
Publisher, Stansberry Churchouse Research