Wednesday, March 7, 2018

Doctor G, I can’t sleep with so many investments on the line!

This stock market is moving higher and higher. The bull market started in March of 2009 or so and now we’re in March 2018 that is a nine-year long bull market. Yes, there are many reasons why this market may go up higher and we gave you some tools in earlier posts to reduce your risk. But your stock portfolio risk will increase with higher prices; that is a fact too.  Ask yourself, how much longer and how much more upside? Another 10 or 15% in 2018?  And then what? A 30% crash followed by years of underperformance when the market reverts back to its long-term average?

I get it that when we hold on to our investments that we will collect a significant amount of dividends over time. That when reinvested especially at depressed prices that our negative returns may be less severe. Too much cash could be detrimental if we missed out on the rebound as well. But when prices go up to ridiculous levels? Do we say, well all those profits are smoke and mirrors?  It may take a very long time to recover those ‘smoke-and-mirror’ profits.  There must be a balanced approach, after all, we learned from our earlier discussion on the ‘active management’ of the Dow Jones that only a fraction of the original investments survived over the years. A true buy & hold strategy may have only resulted in GE holdings and even those are currently in trouble! So if it wasn’t for those D0w Jones ‘portfolio adjustments’, a true buy & hold portfolio may have been a disaster!

If your profits get so high that you have trouble sleeping at night or you worry about your holdings in spite of having hedged it with cash and shorts or gold or puts or whatever then you probably have still too much risk in your portfolio. Better to sell some. Where to start? Well, say you have juicy gains in your RRSP or TSFA, will a sell off and losses result in tax credits as may happen in unsheltered accounts?  No. So these are accounts where you really have no protection against losses. Especially the RRSP where the government will fully tax any capital gains but doesn’t help you with capital loss tax credits. I suggest, it is here where you take profits first, Although the TSFA doesn’t tax your profits, neither does it help with tax credits if you lose and you don’t have a dividend tax credit. Worse, U.S. derived dividends are subject to with-holding taxes.  With that it is clear where we should start taking profits.
Next, the stocks that rose most during the bull market tend to fall most during the following crash. So FAANG stocks are extremely vulnerable. Consider taking at least some profits.  Canadian Banks have done exceptional well over the last decade or so, especially including dividends. They are not overly expensive, but neither are they cheap. Commodities are extremely cheap right now, yet they still might be hit in a downturn. My tendency is holding on to them but don’t let them form a very large portion of your stock portfolio.
If you have a significant portion in cash and you hold more hedges than you own stocks long, chances are you will make actually make money during a coming downturn. This is how you learn to start loving downturns that typically scare the you-know-what out of many investors. Now you will sleep a lot easier and if I (or you) are wrong and there is no down turn what is the risk you took – bit of underperformance? Isn’t that what many investment masters tell us: Rule 1, do not lose money; Rule 2, do not lose money and rule 3, yes you guessed it, do not…  Capital preservation may sometimes be the best way to stock market out performance. As they say, no-one has gone broke taking profits.
As always, never make drastic moves. Do a little bit at a time. If you did something wrong, you may still have the chance to correct.

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