I’m celebrating 23 years of marriage this week. Yes, it is a celebration as I am still very happily married and it is worthy of celebrating as those digits have been very much earned by both parties over the course of time. To be where we are is an accomplishment that encourages us both for the decades to come. Whatever may lie ahead, regardless of whoever is currently snoring the loudest or is packing a little extra around the waist, we are in it for the duration. I do not even know who I would be outside of this relationship.
However, I do not offer this undying loyalty to a very fickle partner I have danced with on and off for over 20 years now; Ms. Market. This bi-polar vixen offers much but can also be a very high maintenance partner. She plays with your head, your emotions, and coldly goes about her business as if her whims are completely removed from any consequence you might bear. She throws her head back and laughs at your retirement plans and scoffs at your heartfelt pleadings to stop her abuse. And then just as quickly woos you into complacent submission until you are completely trusting, vulnerable, convinced her love is real only to dash your dreams once again.
If you are one who is truly in it for the long haul, buy and hold, buy more on the dip, and trust and believe because time is on your side, then this article may be of interest but not likely appropriate for you. You have made your vow. Additionally, if it is your desire to maximize your equity returns and if you are willing to risk a potentially abusive relationship then again, this may not be appropriate.
However, if you are not emotionally attached to this mercurial beast and are not willing to risk an abusive relationship the following may be of some interest.
I recently had a conversation with a corporate client whose board was wrestling with how to best manage risk. Below I have highlighted the four options I brought up as food for thought to help guide their decision making.
Ignore it. Stock portfolios should be long term in nature. Investment decisions should not be made according to short term or medium term uncertainties or fears.
Benefit: This likely produces the best long term return if stocks outperform over the long term.
Problem: Potential large swings in account value might make account holders (wives, husbands, or other parties of vested interest) nervous making it difficult to maintain this strategy to avoid selling at a large loss and potentially missing the ensuing rebound in prices; selling at a low instead of a high in account value if stocks do indeed rebound.
Sell some of the investments now. This preserves current gains and reduces exposure to loss should a downturn occur.
Benefit: Risk is reduced. Gains are kept.
Problem: How much should be sold?
Problem: Under what circumstances should it be reinvested?
Problem: We earn next to nothing sitting in cash while we wait. (see April’s article for a response to that problem)
Problem: Markets might continue to go higher which means we may have to buy again at higher not lower prices.
Keep account fully invested but agree upon at what level assets are sold into cash.
Benefit: An agreed upon approximate maximum loss offers comfort and can protect the remaining balance of account.
Benefit: If the account continues to work higher gains are added as it remains invested.
Benefit: No internal cost to having this preset dollar value maintained.
Problem: Same problems as in option 2 if the sell price is reached. How and when do we get back in?
Keep account fully invested but purchase put options at current or some agreed upon value lower than current account value.
Benefit: If the stock market continues to work higher gains are added as it remains invested.
Benefit: Allows us to remain fully invested knowing that we have something going up when the other investments are going down.
Benefit: As with Option 1 there are no decisions to be made as to whether or not to buy and/or sell.
Problem: The cost of doing this will be a drag on returns if returns continue to be favorable.
Problem: This gets more expensive the more volatile the market gets or the more volatile people think it will get.
I cannot ever remember the cost of this insurance being lower than it is today. The fact that it is very inexpensive to purchase these protective puts tells me that virtually no one thinks that stocks can go down. They may be right. In which case we will have spent money on portfolio insurance and thankfully never needed it. No one hopes to get into a car wreck to maximize their car insurance premium dollars but they pay the bill in the hopes of never using it. If you would like to explore this further with regards to your current allocation here at Arbor please reach out to either Matt or myself to explore this in more detail with regards to your situation. We will be able to show you in very transparent terms what his would look like for you.
Using protective puts not only allows clients to rest assured that their market losses will not go beyond their chosen “deductible” but this technique can also be used to add new monies even at these all- time highs knowing that losses can be mitigated. If the stock market continues to rise the cost of insurance at today’s prices gets cheaper. Think of it as a prenuptial agreement going in.
For now, I am off to spend time with my bride and focus on anything other than the stock market for a few days.