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Overweight Risk Management

            Yes last week was ugly and yes everyone has the same question – Is the Bull Market Over?  While our heart rate quickens and we become more prone to emotionally devastating trading behavior, let’s review some best “risk management” practices.  Hint – I’m not going to answer the question the way you want me to.


Should I Sell Everything?


            We talked about this specifically at our annual meeting last week as a pre-emptive question posed on our “What’s on your mind” section.  Should I sell everything?  Is now the time to “cash out”?  Let’s digest this and use it as a learning tool at the same time.   First of all, the notion of selling EVERYTHING or CASHING OUT,  is really a gambler’s mentality and even a gambling term – cash out your chips right?  We are investors not gamblers – we own companies, sectors, industries and selectively countries that are growing, generating revenue and offer us the promise of capital gains, income and or dividends such that our hard earned capital will do something more than sit in a bank earning zero.  This prospect for wealth accumulation does not end at any time other than when we might need our investment capital or at the point of our deaths.  I don’t like cat food anymore than you do but I also know that failing to invest our savings and retirement funds will not get us where we need to be in terms of our net worth post retirement and that’s assuming you are very diligent about saving.  Back to the point.  Gamblers are in it for entertainment by and large.  They want a quick buck, a big win, some free drinks and a little adrenaline rush.  This mentality cannot find its way into your real money and your investments.  It leads only to sadness and serial mistakes based on greed and fear.    I am the worst gambler in the world and not someone you would want to invite to Vegas because I’ll just bitch all day about the low probabilities of success.


            Second, when we ask the question of whether “the market” is putting in a top, we’re really announcing our sole focus on market indices and ignoring the fact there is a world of options outside of index investing.  Personally, I am not smart enough to know what “the market” is going to do in the long term and thus I don’t like putting myself in a position to guess at what the market (or my market index funds) might do today or tomorrow or in 5 years.  If you think about it, indexers have an extra burden of making that decision.  They assume that they will know when to get out and when to buy.  Market timing is tough, trust me I’ve been at this for 20 years.  The evidence shows that the vast majority of buys and sells among indexed securities are done quite literally at the most inopportune times possible.  Indexers repeatedly buy high, hold their positions through all sorts of carnage and then sell at the lows (within a day or two) when they can’t stand to lose anymore.  The evidence is just too damning to suggest anyone has the internal discipline to do it well on a repeat basis. Meanwhile, we are all told by the industry that A.  You can’t beat the market indices and B.  All you have to do is buy and hold for the long term.  Point A. may be true but I’ve never met an investor capable of executing point B.


            So what is our best bet to manage risk in our portfolios without subjecting ourselves to the Sell All decision crowd?  We have lots of options and systems and this is what we do.  One option is to upgrade your positions to things that don’t have as much daily volatility.  Three weeks ago, we sold all of our Internet funds (Green line) and bought Consumer Staples funds (Red Line) on the same day (9/29).  See below



          Since that day, the sold internet funds dropped almost -7% through last Friday while the Consumer Staples funds lost -0.54%.  We are still invested but simply jumped over to a less volatile sector to play a little defense. 


            Another option is to set stops and just sell positions as they break those stops.  Probably the most simply among technical guys like us is the use of the moving average  - shown in purple below.  Moving averages work very well for bond type positions or slow moving securities that tend to trend well in their price action.  The Red line in this chart is the High Yield Corporate bond ETF (HYG) which we sold in mid July (white line). 



          High yield corporate bonds rolled over this summer and as one of our major food groups in our Retirement Income strategy we were “stopped out” of many positions.  Since the end of July we have been nearly 80% in cash in this strategy.  We took profits at a great time when the question of Selling All wasn’t even on the table.  Now we’re looking for new buys and have some nice profits booked and safely sitting in cash.  The trick with stops is knowing where to put them for various types of securities and following them on a daily basis.  After nearly 50 days of markets declining around the world, we have been stopped out of many positions in all investment strategies and now sit with 30-50% cash. 


            Finally, perhaps the most important thing we can do to manage risk appropriately in our investment portfolios is to maintain the right mix of stocks, bonds, cash and alternative type securities.  This is the obvious notion of diversification and it matters.  After years of rising stock prices, it goes without saying that some investors have become wildly overinvested in stocks and have not been very disciplined about staying somewhat balanced.  Mind you, I am not a fixed portfolio kind of guy and I do believe that an overweight position in stocks is appropriate – or perhaps an underweight position in bonds is a better way to say it.  Regardless, while we want to own non-correlated securities in our portfolios, we also need to maintain an overweight focus on risk management in all asset classes.  Our own “blended asset” strategies (All Season, Gain Keeper and Foundations) have predefined maximum allocations to stocks, alternatives and bonds.  They are 75%, 30% and 30% respectively.  Today, these strategies are roughly 45% in stocks, 7% in alternatives and 10% in income bearing securities.  The rest is in cash waiting for the next great buy to develop. 


So is the stock marketing putting in a long term top?  I’m so glad I don’t really need to answer that question J


Have a great week


Sam Jones