Since 2007, the Dow Jones Industrial Average has gained more than 17,000 points, but as you can see from the following chart, the ride has not been without volatility. After the initial rebound following the recession, the market nosed down in the last half of 2011, and again in 2015 and 2016, leaving investors wondering if the bull market was coming to an end. Of course, it wasn’t, and markets have continued to set new highs since.
However, what goes up must come down, and while my investment newsletters, Wall Street’s Best Investments and Wall Street’s Best Dividend Stocks are all about finding fabulous—and profitable—recommendations for our readers, we would be remiss if we didn’t also offer ideas to protect your portfolio, in times of pullbacks or excessive volatility.
For example, investors who merely “stayed the course” in declining cycles had a wild ride, and those who didn’t adequately protect their portfolios probably ended those periods in the red. They made the same mistakes that many investors make: They love to buy stocks and they hate to sell them.
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When the market looks enticing, they become so excited that they begin to buy stocks willy-nilly, with no thought to a balanced portfolio. And when the market drops, they become frozen, not knowing whether they should continue to buy more, to take advantage of the lower prices or just bail out and sell everything. And the sad result is usually this: When under pressure, investors will generally make exactly the wrong decision!
In essence, they fail to plan.
But you don’t have to make the same mistakes. Instead, with a little thought and planning, you can create an all-weather portfolio.
Since the beginning of the year, investors have been on a market seesaw, with multi-hundred point daily gains and losses almost becoming the norm. And in such volatile markets, it’s more important than ever that investors not only consider investing for gains, but also invest in protecting their existing portfolios.
Now, I’m not saying you won’t ever lose money, because there are no guarantees in the stock market. But there are steps you can take to minimize your losses and also maximize your profits.
Protect Your Portfolio in Four Steps
1. Set a price target the day you purchase your stocks. Your target should be based on the P/E of your stock, multiplied out by expected future earnings. I recommend that you at least think about what price your stock can achieve within 18-24 months. And that should at least be a 30%-50% gain. If it doesn’t have that potential, keep looking.
Going forward, when the stock hits your target, reevaluate it and determine if it has the ability to continue double-digit price gains or if you would gain more by cashing in now and using those funds to purchase a different stock with more potential. Many of the contributors to my newsletters make this decision easy for you, by providing targets for their recommendations, and often cash in just a portion of the holding to take some profits and let the remaining half ride toward a new target.
For example, in a recent issue of Wall Street’s Best Investments, we featured Ionis Pharmaceuticals, Inc. (IONS), recommended by John McCamant, editor of The Medical Technology Stock. John set a price target of $70—about 36% higher than the shares were trading at that time. In setting his target, John looked ahead at the company’s expected two FDA approvals and how they may impact forward analysts’ estimates.
2. Set a stop-loss limit the day you purchase your stocks. For aggressive investors, the stop loss could be 30% or more. For more conservative investors, you might be happier with a stop loss of 10%. The actual percentage is not as important as being disciplined in exercising the stop losses. Sure, no one likes to lose money, but a stock riding momentum down can clean you out in no time, so it’s best to take your losses. If the stock bounces back, you can always buy back into it. Many of our advisors provide stop losses for you, but it’s always a good idea to consider your own investing strategies when setting your stop losses.
With technology stocks and biotech stocks—which tend to be more volatile than more conservative companies—it’s a good idea to set your stop losses a little wider. For example, with Ionis, I would suggest a 30% trailing stop. That way, if the market just causes the shares to slip a bit one day, it allows you to ride out a temporary drop, without inadvertently cashing out of a company with excellent long-term potential.
3. Diversify your portfolio to reduce your overall portfolio risk, as well as volatility. That means creating a portfolio with non-correlating assets, which, theoretically, results in assets that react differently to market catalysts. When market action causes some of your assets to decline in value, others should rise, effectively allowing you to protect your portfolio from declining at the same time.
Consequently, you should own small-, mid- and large-cap stocks; companies in different sectors; and value and growth stocks.
And while you may think you are properly diversified because you may have 10 different technology stocks that operate in totally different segments, remember that they are all still technology stocks—companies that tend to do very well when the economy is steaming ahead and folks have plenty of money to upgrade.
You should also have exposure to international stocks, either through owning multinational companies or via exchange-traded funds. And don’t forget about fixed-income investments. In rising rate cycles (like the one we are now in), bonds can be attractive. Additionally, some investors may want to add currencies, commodities and real estate to their portfolios, as hedges against stock market volatility.
With 40 or more recommendations coming your way each month in Wall Street’s Best Investments, you won’t have any problem choosing stocks from almost every industry to help you diversify your holdings.
Of course, the actual composition of your portfolio will depend on your personal investment goals, your age, and your risk profile, so make sure you know the kind of investor you are so that your portfolio will match up to your goals.
4. Put some dividend-paying stocks in your portfolio. Dividend stocks are a great hedge against inflation and provide terrific portfolio gains in down market cycles. Years ago, during the tech boom, I began adding dividend stocks, such as regional banks and Real Estate Investment Trusts (REITs) to my portfolio. The payoff was great! When tech stocks hit the dust and the market took a downturn, I was still earning some great returns on my dividend stocks. Many investors neglect these companies as they think they are too boring. But what’s boring about making money?
And the pages of Wall Street’s Best Dividend Stocks also include a nice array of companies that pay dividends. For example, in today’s Daily Alert, Jack Adamo of Jack Adamo’s Insiders Plus recommends mortgage REIT Annaly Capital Management (NLY), which has an 11.39% annual dividend yield.
Jack had this to say about the company: “From 2000 through 2017, Annaly common stock outperformed the S&P 500 by 69%. What’s more, it held its ground much better during the 2008 crash. At its current price, the stock is selling at a 17.5% discount to tangible book value.”
With so much cash available to companies over the past few years, stocks from of every genre—including technology and emerging markets—will often pay a dividend. And that just adds to your profits.
Last Word on Protecting Your Portfolio
For most investors, following the above four steps will help protect your portfolio against normal up-and-down market cycles. While an undiversified portfolio can give you tremendous gains—if you are lucky enough to choose only “home-run” stocks—the plain truth is that most investors, individual or professional, don’t have a crystal ball. And stocking your portfolio with just one type of company or sector, no matter how promising, is a recipe for failure, long-term.
So, do yourself a favor, and take advantage of the tools that are available. With technology today, it’s never been easier to protect your portfolio.
If you’d like additional stock recommendations to help you diversify your portfolio, consider joining Wall Street’s Best Investments which I edit. Each day, you’ll receive a Daily Alert featuring a new stock that one of the analysts recommends, and each month you’ll get the whole list of stocks from the Wall Street’s best gurus.
Nancy Zambell, Editor of Wall Street’s Best Investments, has spent 30 years helping investors navigate the minefields of the financial industry. Nancy scours more than 200 advisories and research reports to select the top recommendations, which she collects for you in this easy-to-read digest.Learn More