Saturday, January 6, 2018

How to ride the current bull?

Over time I have discussed many aspects of investing and, I assume you have by now a stock and fixed income portfolio in place. One thing really struck me while listening to an investor presentation by Kevin O’Leary the Dragon Den star. When he talked ‘fixed income’ he considered his real estate to be part of his fixed income portfolio. I think, in this day and age of low interest rates that makes sense because apart from short term debt instruments (maturing under two years) I don’t see much benefit in owning debt.
Right now, after riding a nearly 9-year-old bull market in the U.S., having protected ourselves with a multi-asset class diversified portfolio is a great defensive strategy. But it is also true that during the euphoric final stage of a bull market there is lots of profit to be made. That is why I often compare riding a bull market with playing musical chairs. The last buyer at the absolute peak will hold the proverbial bag.
But don’t forget that after lagging the U.S. for many years, finally other markets have started to pick up as well. Last year Western European ETFs typically returned close to 20%. This year, with a pick-up in commodities our own Canadian stock market may finally do good as well.  Thus, one way of protecting us from a sudden turn for the worst in a U.S. stock market would be to diversify into different regions of the world as well.
And then there are things such as Gold – not the best performer lately, but then gold and gold miners often show little correlation with the rest of the stock markets and so having 5 to 10% invested in gold bullion, gold ETFs and some mining companies is a good form of diversification as well.
Now that we are nearing the peak of a bull market, we should apply trailing stop-losses on our stocks to limit the damage from our mistakes. We could also start selling off holdings that exceed 5% of your stock portfolio (which is the maximum investment we recommend for individual stocks). This is part of the normal portfolio rebalancing process, but rather than reinvesting this money keep it in cash. Now how much cash should you hold?
In past blogs we have shown that it helps to buy a stock cheaply, but we have also shown that when holding stocks for many years the total return is not that severely affected.  Also, we have seen that half if not more of the profits are made from dividend income. Even if you go through a crash, as long as you don’t sell your stock holdings, prices will recover and then some overtime. That combined with a continuous dividend stream (provided your dividend paying companies don’t go broke) should outperform a strategy of accumulating cash and waiting to buy stocks at low prices while missing out on collecting said dividends.
What really your main concern should be is forced selling of your assets. Especially panicking and selling at the bottom of a bear market is one of the most damaging things you can do to your portfolio. Buying at the bottom of a market may speed up your recovery a bit but as said earlier it barely affects your long-term performance.
Thus, the question is how much cash do I need to avoid getting cash-strapped during the downturn and being forced to sell? Suppose you lose your job during the downturn and you need money to live off. But don’t forget that you may be able to live of severance pay or employment insurance when you lose your job. If you are a business owner you will not lose your job but you won’t make a lot of income either if you get hit during the down turn. So basically, we’re talking about having enough cash on hand to get through the downturn which in the stock market typically lasts 6 to 12 months. Remember August 2007, that is when the market performance flattened and by mid 2008 it actually crashed and by March 2009 it bottomed. So, you only needed cash to get by for 6 to 18 months even during the worst crash in about a century and during those months most of your dividends will keep on coming. Likewise will rents (although possibly reduced) from a rental property portfolio. I think for most of us, having between $50,000 and a $100,000 in cash should do.
That raises the question: but I don’t even have that much as an investment portfolio let be that I own that much in cash!  My answer: Then what the hell are you doing investing in stocks?  First build a cash stash to survive then if you have more mullah, then start investing that extra money in other riskier assets.
Some investors buy put options as portfolio ‘insurance’ for a falling portfolio. But if a portfolio does not fall (significantly) you only keep on paying (and losing) option or better ‘insurance’ premium money.  That would really lower your overall returns and what does it do for you?  It only protects you against stock market volatility but as discussed earlier it doesn’t do anything but lower your long-term returns due to the cost of the premiums.  That will be my strategy over the coming months while riding this bull market.

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