Dec. 16, 2019
I have a wealthy friend who has recently taken investing courses so she can make her own decisions. She has learned about put and call options and other topics I know nothing about. In anticipation of an impending market implosion in 2020, forecast by every financial professional it seems, she intends to sell all her holdings and be completely in cash by the end of 2019. She will then reinvest a year or two later when the market stabilizes and begins its long climb back. I’m wondering if I should take more or less the same approach. I am a single woman, age 82 and a renter. I have about 80 per cent of my money in solid, dividend-paying stocks and 20 per cent in bonds. Would it be wise to ask my broker to put a 5-per-cent stop loss on my holdings so that if there is a decline beyond that, I will end up completely in cash?
Before I answer your question, let me ask you one: What if your friend is wrong and the market doesn’t collapse? She’s going to be kicking herself. Apart from missing out on the market’s future gains, she’ll lose the dividend income from the stocks she sold.
The truth is that your friend doesn’t know what the market will do next year. Nobody does. But on any given day there will always be someone predicting a market collapse and someone else calling for the market to soar.
But let’s say she’s right and the market plunges in 2020. By going into cash now she’ll avoid losses in the short run. But getting back in might be a lot harder than it sounds. Bear markets are usually accompanied by scary headlines, dire economic warnings and pervasive fear. Maybe your friend has nerves of steel, but it’s possible that she will be too freaked out to reinvest any of her cash. Or she might wait until investor sentiment has turned positive, by which time the market will have already recovered.
As for stop-loss orders, I’m not a fan. When you enter a stop-loss order, you’re telling your broker to sell your shares if they fall to a certain price. But all this does is lock in your loss; if the shares subsequently recover, you’ll be left behind. You mentioned that your equity holdings are all “solid, dividend-paying stocks." If the businesses are sound, selling just because the shares have dropped in price doesn’t strike me as a prudent strategy.
Nor do I see any reason for you to use put and call options or other exotic tools. These products have a place in sophisticated trading strategies, but for most small investors I believe that a simple buy-and-hold approach is best.
If you’re concerned about losing a chunk of your capital in a downturn, my advice would be to review your portfolio to make sure that you are diversified across sectors and hold only high-quality companies with a history of raising their dividends. (For examples, see my model Yield Hog Dividend Growth Portfolio.
If you are uncomfortable having 80 per cent of your assets in stocks, you may wish to dial back your equity exposure and put a portion of those funds into a high-interest savings account, guaranteed investment certificates or bonds. But going completely into cash, as your friend is doing, strikes me as a risky strategy that could backfire. I also recommend that you discuss these issues with your adviser.
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