Tuesday, August 20, 2019

Friends Don't Let Friends Buy and Hold

That's the subtitle to this entire blog, and a basic principle of mine.

Many brokers and some financial advisors are going to tell you to stay fully invested all the time. This is a buy and hold strategy. “Just re-balance your portfolio will do the trick!” This assumes that you have a properly balanced portfolio, which could be something like 70/30, which is 70 percent stocks (equities) and 30 percent bonds. The ratio could be something different, but the principle is the same.

This is bad advice. In fact, this buy and hold advice is so bad it should be criminal. To take a lesson from 2008, if you had done this buy and hold and re-balance crap, both your stocks and bonds would have tanked. You would have suffered losses approaching 60 percent. This is unacceptable. It would have taken the average portfolio nearly 6 years to return to break-even.

Granted, sometimes bonds will provide a safe haven, but not always. And other asset classes, like commodities, can also provide some protection, but these are for professionals.

Before you invest, have a risk management plan. In other words, decide how much loss (which actually might be just a downturn from a profitable portfolio) you are willing to take. Don’t ever lose more than 7 percent on a particular position and don't risk more than 2 percent of your entire portfolio on a single position. I use a dollar method, rather than percentages, while keeping in mind the 7 percent and 2 percent rules. 

For example, if I’m thinking of buying XYZ company (or maybe it’s an ETF), I decide first that I’ll get out if it goes down by $500. I use this as a guide for my position size. I set a stop loss order at the same time I add the position to my portfolio. If the investment moves higher (and if I’ve done the proper research and bought it wholesale rather than retail, which is a whole separate book), I raise my stop appropriately.

While money markets may only pay about 2% right now, I’d rather earn 2% during a bear market, than lose 50 or 60 percent.

Try to ride out a bear market during a recession — or any other time, is bad advice and can be devastating to your portfolio.

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